Unisys Corp (UIS) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Unisys Corporation second quarter earnings release conference call.

At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following today's presentation.

It is now my pleasure to turn the floor over to your host, Jack McHale, sir, the floor is yours.

Well, thank you, operator.

And hello, everyone.

And thank you for joining us this morning.

About an hour ago, Unisys released our second quarter 2004 financial results.

With us this morning are Unisys Chairman and CEO Larry Weinbach, our President and COO Joe McGrath and Janet Haugen our CFO.

Larry and Janet will share some opening remarks with you.

And then we will be available to take your questions.

Before we begin, I want to cover just a few housekeeping details.

First, today's conference call and the Q&A session are being webcast by the Unisys investor website.

A replay of the webcast will be available on our Web site shortly after the conclusion of the live event.

Second, today's presentation, which is complimentary to the earnings press release, includes some non-GAAP financial measures.

Certain financial comparisons made in this call will be with and without the impact of pension accounting.

We believe that providing this non-GAAP information is meaningful to fully understand our operating performance.

Our reported results in the second quarter of 2004 include 24.8 million of pension expense, compared with 7.9 million of pension income in 2003.

This is a $33 million negative swing on a year over year basis.

On the Unisys investors website, we have provided a reconciliation of our reported results on a U.S.

GAAP basis compared with our results excluding the impact of this pension accounting.

Third, you can find on our investor website the earnings release and the associated spread sheets as well as presentation slides we will be using this morning to guide our discussion.

These materials are available for your viewing as well for downloading and for printing.

Finally I would like to remind that you 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 periodic reports as filed with the SEC, and copies of these SEC reports are available from the SEC and also on the Unisys investor website.

Let me now turn the call over to Larry.

Thanks, Jack.

And hello, everybody.

Thank you for joining us this morning.

This was a challenging quarter for Unisys.

As announced in our release last week, our second quarter 2004 results came in below the original expectations that we gave in our earnings call in April.

This was very disappointing for all of us.

Particularly given the track record of consistency and earnings growth that Unisys has established in recent years.

This morning, I will spend some time discussing the key factors behind the weakness in the quarter.

More importantly, I will discuss how we plan to regain our momentum and to continue our profitable growth.

I will also update our financial outlook for the rest of the year.

But I would like to begin by having our CFO, Janet Haugen, take you through our actual results in the quarter.

Janet?

Thank you, Larry.

And hello, everyone.

I, too, was disappointed with our performance in the second quarter of 2004.

We have succeeded in recent years by staying focused and executing against our strategy.

As Larry will outline later, we are taking specific actions to enhance our execution so that we can regain our momentum.

To begin with the details on the the financial results in the quarter please turn to slide one of the presentation material.

This slide summarizes our original April expectations for the second quarter, our revised expectations as communicated last week, and where we actually came in for the quarter.

At the top line, we had originally expected to show mid-single digit revenue growth over the second quarter of 2003.

That would have put our second quarter 2004 revenue in the $1.5 billion range.

Our actual revenue came in at 1.39 billion, down 3% year over year.

Overall, our revenue for the second quarter of 2004 came in about 100 million below our original expectations.

About 80% of this revenue shortfall came in our services business.

And about 20% in our technology business.

Equivalent to the services technology split in our overall business.

At the bottom line, we originally forecasted EPS excluding the impact of pension accounting, of between 14 and 17 cents in the quarter.

Our actual EPS came in at 11 cents.

This compares to EPS of 14 cents excluding the impact of pension accounting in the year ago quarter.

The table in this slide also shares our forecasted and actual earnings per share including the impact of pension accounting.

Slide two shows more details on our actual second quarter results.

As I mentioned our reported revenue declined by 3% over the year-ago quarter.

On a constant currency basis, our revenue declined 7% in the quarter.

Lower revenue and higher SG&A impacted our operating margins in the quarter.

Our operating margin excluding pension accounting declined 210 basis points, to 3.4% in the second quarter.

SG&A expenses excluding the impact of pension accounting, increased 10% in the quarter from a year-ago period and I will discuss the SG&A expenses later in my remarks.

We reported second quarter 2004 net income of 36.3 million, excluding the impact of pension accounting.

Which was down 23% over the year-ago quarter.

And as I mentioned, our earnings per share excluding pension accounting, came in at 11 cents in the quarter, down 21% from a year ago.

This table also shows our EPS on a reported basis, including the impact of pension accounting.

Slide three shows our second quarter revenue by business segment.

Services represented 83% of our revenue in the second quarter, with technology accounting for 17% of revenue.

Services revenue was flat in the second quarter from a year ago, while our technology revenue declined 12%.

Slide 4 breaks down our services revenue in the second quarter.

Outsourcing revenue declined 1% and represented 36% of our services revenue in the second quarter.

Within outsourcing, we saw continued double digit growth in business process outsourcing.

However, this was offset by revenue declines in data center outsourcing, and in infrastructure managed services.

Consulting and systems integration revenue grew 7% in the second quarter, and represented 36% of our services revenue in the quarter.

In terms of our other services line, infrastructure services revenue was down 15% in the quarter, this was a key area of weakness in our services business, and Larry will talk more about that this in his comments.

Finally, core maintenance grew 1% in the quarter.

Turning to technology, please turn to slide 5.

Our enterprise server revenue declined 5% in the second quarter of 2004.

Within enterprise server, ClearPath revenue was down single digits while ES7000 sales grew slightly.

Our specialized equipment business declined 34% in the quarter, driven by lower sales of semiconductor test systems, and payment systems.

Moving to slide 6, on a geographic basis, our U.S. revenue declined 5% in the second quarter.

Our international revenue was flat in the quarter, as growth in Europe offset declines in other international markets.

On a constant currency basis, our international revenue declined 8% in the quarter, with Europe up slightly on a constant currency basis.

Overall, currency had a positive four percentage point impact on our second quarter revenue, as the U.S. dollar remained weak against other global currencies.

We anticipate the currency will have about a three percentage point positive impact on our third quarter 2004 revenue comparison if rates remain the same as today.

One additional note on revenue.

From an industry standpoint, we saw revenue strength in the federal communications and commercial industries in the quarter.

Revenue declined in our financial and transportation industries.

Worldwide orders grew in the quarter due to strong growth in outsourcing orders.

Orders excluding outsourcing were down due to weak technology and infrastructure services orders.

Moving to expense trends in the second quarter, please turn to slide seven.

Excluding the impact of pension accounting, SG&A expenses increased 10% or $23 million in the second quarter.

About half of this increase was due to the impact of foreign currency.

The remainder of the increase was primarily due to several one-time items, including the move of our federal headquarters into a new facility, as well as expenses related to the first time effort associated with the internal controlled documentation, testing, and reporting requirements of Sarbanes-Oxley.

Excluding the impact of pension accounting, SG&A expenses represent a 19.3% of revenue in the second quarter, compared with 17.2% of revenue a year ago.

R&D expenditures were flat in the quarter, excluding pension accounting.

And we continue to invest in our high-end enterprise servers and 3D VE industry solutions program.

Other income was 24 million in the second quarter compared to 11 million a year ago.

The higher other income primarily reflected foreign currency gains in the second quarter of 2004, compared to foreign currency losses a year ago.

Turning now to margins, please turn to slide 8 of the presentation materials.

Excluding the impact of pension accounting in both periods, our overall operating margin decreased 210 basis points to 3.4% from 5.5% in the year-ago quarter.

Slide 9 compares the operating margins in our services business in the second quarter of '04, to the year-ago period.

Excluding the impact of pension accounting, services operating margins declined 270 basis points to 2.5% from 5.2% a year ago.

Slide 10 shows the operating margins in our technology business.

Excluding pension accounting, our technology business generated a 6.7% operating margin in the second quarter of 2004, up from 6.4% a year ago.

The margin improvement was driven by a higher mix of higher end ClearPath shipments in the quarter.

Moving to cash flow and balance sheet highlights in the quarter, please advance to slide 11.

We generated $98 million of cash from operations in the quarter, which was down 15 million from the second quarter of 2003, principally due to the lower income.

Total capital expenditures in the second quarter were $104 million, up from $100 million a year ago.

After deducting capital expenditures, we used $6 million of free cash in the quarter.

Please note that a reconciliation of cash from operations with free cash flow which is a non-GAAP measure can be found on the Unisys investor website.

A few other notes on cash flow on the balance sheet, depreciation and amortization was 97 million in the second quarter of 2004, compared to 86 million in the year-ago quarter.

We ended the quarter with $643 million of cash on hand after spending $13 million on two acquisitions, and $18 million in reducing short-term debt.

Looking forward, our expectation for capital expenditures for the full year of 2004 is in the range of $400 million.

And our expectation for depreciation and amortization for 2004 is in the range of $380 million.

And we are targeting free cash flow of more than $50 million in 2004.

Now, I would like to turn the call back to Larry.

Thank you, Janet.

Now that you have an overview of the numbers, I would like to discuss some of the factors that led to the shortfall in the quarter.

In the final weeks of June, we saw an unexpected slow down in certain area of our business.

This weakening occurred primarily in infrastructure services and in enterprise servers.

Even though about 80% of our revenue comes from services, the last two weeks of the quarter are critical for our business.

As with many companies in the I.T. industry.

This is clearly the case in our technology business, where we typically book and deliver key hardware systems in the final few days or week of the quarter.

In services while we have succeeded in recent years in expanding the amount of our business coming from multi-year annuity business, about 50% of our services business today continues to come from shorter term projects, such as infrastructure services, and consulting and systems integration.

We have assignments in our services business where we work on projects throughout the quarter to implement a new system or software-based solution.

But our ability to recognize revenue and profit is sometimes dependent upon testing, and acceptance by the client.

If the project is delayed, or if it is not completed on time, then the revenue and profit recognition is also delayed.

So in the final weeks of any quarter, there are always moving pieces that we track.

Pending technology and services deals, solutions awaiting client testing and acceptance, services project milestone expected to be achieved.

We must closely monitor all of these.

As part of our forecasting process, each quarter we assess potential transactions in terms of risk and opportunity.

And we balance the risks and opportunities to come up with what we believe is a realistic view of where we expect to end the quarter.

And this process has been proven over many quarters.

What we saw at the end of this quarter, however, was that many of the risks materialized.

While the opportunities didn't.

And this resulted in the shortfall.

In services, we were particularly impacted in infrastructure services.

This is the area of our business where we do network consulting and integration.

We implement rollouts of new distributed desktop and network technologies.

And we provide help desk and third party support.

Unisys provides both short-term and multi-year infrastructure services.

The short-term project work is reflected in the infrastructure services part of our portfolio which as Janet discussed declined 15% in the quarter.

We also provide distributed infrastructure services on a multi-year outsource basis.

This work which we call infrastructure managed services, is captured in the outsourcing part of our services portfolio.

This business also declined, and was the major contributor to our weaker outsourcing revenue.

In addition, while our consulting and systems integration business grew in the quarter, we also saw some impact in this business late in the quarter from client deferrals of new software-based solution implementations.

In our technology business, the shortfall came primarily in the deferral of purchases of high-end enterprise servers.

We saw this both in our ClearPath and ES7000 product lines.

Here, too, our clients constrained their spending on new systems implementations, and upgrades to new server technologies.

And this impacted our revenue and profit in the quarter.

For the quarter from an industry and geographic point of view, we saw the slow down primarily in the United States and Latin America.

And in financial services, and transportation.

Demand in the federal government market continues to be solid.

Our federal government revenue was up mid single digits in the second quarter.

Even against a tough comparison a year ago, when we benefited from the initial rollout of our TSA contract.

Over the past week, we have conducted intensive business reviews with all of our business units and geographies.

From our conversations with clients, we do not see any broad based causes for the slow down in our business.

Let me add that our pipeline of potential opportunities remains solid.

We continue to see good opportunities in business process outsourcing, in industry base consulting and systems integration, and in the federal government market.

Areas where Unisys is well positioned.

We continue to work on more than a dozen opportunities with multi-year revenue in excess of $100 million.

Where the clients are expected to make a decision within the next 12 months.

In fact, we were complete pleased by our double digit services order growth in the quarter.

Which was driven by the signing of about 500 million of multi-year services contracts.

Our largest order was a five-year contract valued at 162 million with the state of Louisiana, to provide Medicaid administration services for the Louisiana Department of Health and Hospitals.

This contract has the potential of expanding to about 300 million over ten years if all options are exercised.

We also extended our long-time outsourcing partnership with the Brazilian Federal Government Bank, Caixa Economica Federal.

In a two-year contract worth over $60 million, Unisys will provide information technology services to support the bank's home loan operations which are the largest in that country.

In the area of infrastructure managed services, we received a nearly 27 million five-year contract, for remote network management services from a major U.S. financial institution.

We also won a five-year contract valued at more than $50 million to provide infrastructure management and support for a major European financial institution.

In our federal government business, we were pleased to be selected by TSA for its registered traveler pilot program which will enable certified frequent flyers to move more quickly through airport security checkpoints without compromising the security standards that TSA has implemented at the airports.

Unisys is implementing biometric technology, including Iris and fingerprint recognition at three of the five airports included in the registered traveler program.

This is our second biometric engagement with TSA in less than a year.

So there are many positive initiatives going on at Unisys.

We're well positioned in growing areas.

And we're working hard to regain our momentum and to continue the record of profitable growth that we've shown in recent years.

In the near term, the slow down that we experienced in June, in infrastructure services and enterprise servers, has continued in the third quarter.

While we expect to recover most of the second quarter deferrals later in 2004, client demand and infrastructure services and enterprise servers remain slack.

Compounding this weakness is the normal seasonal slowness that we typically see in technology sales in the third quarter due to summer vacations.

In addition, we had expected to begin seeing some benefit in the second half of 2004 from Check 21 related business, among U.S. banks.

This business has not yet materialized in a significant way.

While we're doing many initial smaller consulting projects with major U.S. banks, the institutions are reluctant to commit to larger new systems integration rollouts, and business process outsourcing opportunities, until they get a clearer picture of how Check 21 may impact their own business.

While we continue to see the Check 21 area as a significant growth opportunity, where Unisys is very well positioned, our view is we will not start seeing a meaningful benefit from Check 21 until 2005.

A final necessity is to maintain our tight control over our expenses.

And we're focused on doing this.

We're pursuing a number of initiatives to regain our momentum.

First, we're going to continue to focus on our value-added strategy, and the key strategic priorities that we set out at the beginning of the year.

These priorities are to continue growth in our annuity based revenue, particularly in business process outsourcing.

To drive improvement in our services margins.

To drive growth in enterprise security in the ES7000.

And to continue enhancing the image of Unisys in the marketplace.

We remain focused on these priorities because they offer strong opportunities for profitable growth and Unisys has the capabilities to capitalize on these opportunities.

To strengthen our position in our focus growth areas, we recently made two small strategic niche acquisitions.

In early July, we acquired Base Consulting, a specialized provider of services and solutions to the U.S.

Intelligence and Defense community.

With base, we have gained about 90 highly-experienced individuals with excellent capabilities, including high level security clearances.

This acquisition builds on our existing strengths in security and it enhances our position in the intelligence and defense market.

Also, we closed our previously-announced acquisition of key assets of E-presence, which enhance our suite of identity management solutions in the security market.

These acquisitions follow other recent niche acquisitions of KPMG Consultants in Spain, and the former KPMG consulting practice in Belgium.

Second, to achieve our strategic objectives, we're placing a stronger emphasis across the company on operational execution.

Our new President and COO, Joe McGrath, is leading this effort, to improve inter-unit collaboration and execution by presenting the full suite of Unisys end to end capabilities to clients.

This increased focus should enable us to improve performance in our managed infrastructure services business.

Our third initiative is to drive greater sales volume in our enterprise server business.

We have great technology with our ClearPath and ES7000 servers.

An we must do a better job of leveraging this technology for growth.

While we don't expect ClearPath to be a growth driver, we have a loyal and large client base, and will continue to enhance ClearPath with leading edge technology that meets these clients' demands.

We will roll out some upgraded ClearPath models early in the fourth quarter.

The ES7000 has been break-through technology since we announced it several years ago.

It has enabled us to enter an entirely new market for high end intel-based servers.

It has opened us up to new client accounts.

More than 40% of our ES7000 sales continued to go to new Unisys clients.

New clients in the second quarter includes Daimler-Chrysler and Ray-Vac.

We need accelerate growth in our ES7000 sales, look for two significant new announcements in the next 60 days.

Finally, we're continuing to place a strong emphasis on controlling our expenses throughout the entire company.

We will continue to concentrate more of our selling, general and administrative dollars on revenue producing brand enhancement areas such as our 3D visible enterprise positioning.

We believe 3D VE is a ground-breaking initiative that has given Unisys a leadership profile in the area of business blueprinting.

And we continue to receive very positive feedback from clients and industry analysts.

We believe these initiatives will enable us to regain our financial momentum and consistency.

Now, please turn to slide 12 for an overview of our financial outlook for the remainder of the year.

At the bottom line, we expect full-year 2004 earnings per share, excluding the impact of pension accounting, of between 68 and 72 cents on low single digit revenue growth.

The break-out between the third and fourth quarters is more difficult to call.

Last year, we had a strong third quarter in our technology business.

This year, we expect our second half 2004 technology sales to approximate second half 2003 levels, but the break-out by quarter will not resemble last year.

Therefore, we expect earnings per share, excluding the impact of pension accounting, to approximate 8 cents to 12 cents in the third quarter on flat revenue compared to the third quarter of 2003.

The second quarter has been a difficult -- and it's been a disappointing quarter.

We are committed to put it behind us, and getting our momentum back.

And we will act aggressively to do that.

I'm convinced that Unisys has the right strategy, the right people, the right skills, and the right portfolio of services and technology to provide the kind of solutions needed by clients in today's marketplace.

We are profitable.

We have a strong cash position.

We are in a dynamic growing markets.

And we will continue to pursue and win new opportunities in the global marketplace.

I am personally committed to it.

The management team is committed to it, and the 37,000 people of Unisys are committed to it.

Now I'd like to open the call to questions.

Thank you.

The floor is now open for questions.

If you have a question, please press star, then one on your touch-tone phone at this time.

If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key.

We do ask that while you pose your question, that you pick up your handset to provide optimum sound quality.

Once again to ask a question, please press star, then one on your touch-tone phone at this time.

Our first question is coming from Ashwin Shirvaikar from Smith Barney.

Please go ahead.

Thank you.

The question is on margins.

Firstly, shorter term, if demand does not come back to what extend can short-term controls help you meet the new guidance?

And the second question is, longer-term margins, do you still expect the 10% target to hold?

Thank you, Ashwin.

First off, on the shorter term, if we experience another quarter like we experienced, I think that our margins will hold where they are right now, I think we're taking several initiatives under way, which frankly should help us with the margins, but as you take the initiative now in the third quarter, we probably won't see the benefit of that until the fourth quarter.

Our overall goal of a 10% margin by the fourth quarter of 2005 for operating in the fourth quarter 2005 is still our goal.

I mean that's still where we want to go.

If we see a systemic downturn in the business, obviously this is going to impact what margins look like.

On the other hand, if this was more of a blip in the road, as we go forward, and we are able to do some of the things that I talked about, we still hold to that same goal.

So we are committed to getting those margins up, and we think we have the right mix of people, and we're in the right industries to do that.

Okay.

And secondly, you know, what are your clients telling you today about demand as well as about why the process started all of a sudden across Techland?

Well, you know, at this point, to be perfectly candid, Ashwin, I'm not sure whether from a technology standpoint it is an industry-wide problem, or we just had something that hit us, you know, the year -- the 100-year flood in the second quarter.

And the reason I say that, we saw a lot of the announcements of the software companies, they came out and preannounced, and obviously, it has created a lot of concern in the technology arena, in the whole technology market.

Clients at this point have budgets which would show increases in spending over last year, but not great increases.

I'm talking about a 3, 4, 5%.

We typically have a very strong fourth quarter.

We are estimating a strong fourth quarter again this year.

As I mentioned, our technology sales for the last six months of '04 will approximate '03, and '03 as you know was a very good technology period for us, but the third quarter right now, it seems to be more back-ended into the fourth quarter.

We obviously go through all the deals that we know about, and we feel that those deals are real.

We anticipate being able to close them.

And that's why when you see the skewing between the third and fourth quarter and as I mentioned in my comments, the last six months looks good, I'm not as comfortable in the breakout between the third and the fourth quarter.

I'm much more comfortable in the six-month period.

Thank you.

Thank you.

Thank you.

Our next question is coming from John Jones of Schwab Soundview.

Please go ahead.

Yeah, good morning, Larry.

Just, I wanted to contrast and compare a couple of your comments, because I -- I'm --

John, you're fading out.

I'm sorry.

All right.

Let me see if I -- can you hear me now?

That's much better, thank you.

You basically are saying that there is no broad-based reason for the slowdown.

And that would lend me to believe that, or look at Unisys and try to understand what the slowdown -- what is creating the slowdown.

Janet said about 80% of the shortfall was in services, and it was approximately 100 million shortfall.

You know, I calculate that to be 1300, 1400 people working for an entire quarter.

And I can't believe that you've got people sitting doing nothing, so it sounds like their contracts that you've been working on, that you haven't been able to take revenue on.

Can you expand upon that issue to try to help us understand what's creating the deferrals or am I incorrect in my assumption, Larry?

John, I'm going to give you a longer answer than you want, maybe, but let me put this in perspective.

Number one, if you look at the second quarter, we won one large outsourcing contract in the 100 million range, the state of Louisiana, we lost one North Carolina.

We announced that we had more than a dozen, we still have more than a dozen.

We are disappointed that we did not close large outsourcing contracts.

We have the Caixa deal of about 60 million.

We had several others in the infrastructure, 50, 27, but we did not close a large outsourcing deal.

They have not gone away.

We're one for two in the second quarter.

We did close more than 500 million or about 500 million.

But that's one part of the issue.

The second part of the issue is, as I mentioned, we do have contracts in our systems integration and consulting part of the business.

We're only about 10% or less, or on percentage of completion.

Therefore we have fixed price contract, milestone contract, and as mentioned by both Janet and me, there are certain instances, we did not meet the milestones or the client delayed us.

So we did have some effort that took place where we weren't able to record the revenue that we wanted to record.

We do have, like everybody does from time to time, there is a couple of contracts that we wish were better, but it is not something that wasn't budgeted or expected as we went into this year, and came up with our forecast.

So I think it is a combination of a bunch of things.

I want to assure you of one thing.

There is no way that Unisys has 1300 people or anything near that sitting on the bench waiting for any kind of job to come in.

But that's -- but that's the amount of revenue that is embodied in the shortfall so it sounds like -- then my question would shall be --

John, let me stop you for a minute.

If you take on an outsourcing contract, you take on people.

Right.

Right?

No, that's true.

But you're telling us that the shortfall was in infrastructure services.

Which tends not to be outsourcing, right?

No, but infrastructure services is two things.

Infrastructure services includes the milestone kinds of projects for the short-term projects, and we also have what we call infrastructure-managed services, which as I mentioned in my remarks falls into the outsourcing category.

So if you look at outsourcing, we had double digit growth in BPO, yet we had a shortfall in infrastructure managed services which is a component of outsourcing.

Uh-huh.

So the real hit we took was our infrastructure services on a project basis was down about 15%.

Our infrastructure managed services, which is part of outsourcing was down.

And that was the largest part of the hit that we took in the services business.

The point I was trying to make, though, is when we anticipated a revenue growth, we did anticipate or hoped that clients would decide, and we could close more of those outsourcing deals and people come along with those deals.

Right.

I don't want to leave anyone with the impression that we have a whole bunch of people sitting on the bench with their fingers crossed.

Then would you -- would you expect the -- these deals that were not revenue, I would assume that in the third and fourth quarter, you will be able to revenue those and hit those milestones.

Or are these contracts that basically the deal goes away?

No, you're correct.

I said in my comments that during the second half of '04, that most of those deals will come through.

I don't want to tell you 100%.

But most of that stuff will get revenued.

The one thing, and the reason why we took down our revenue and our earnings in the third and fourth quarter was because we hadn't closed some of those outsourcing deals.

We wanted to be a little more realistic in what we were telling to the marketplace.

So we continue to have a strong pipeline, but we looked at this and said even if you close something in July or August, and August, as you know is tough to close anything--

Right.

-- you don't get the benefit until next year, the real benefit.

Okay.

And just a clarification.

Just because I didn't -- I didn't hear it.

I came on late.

I'm sorry.

Janet said there was strength and weakness in certain verticals.

I heard federal and communications were strong.

I heard transportation was weak.

Could she just add the others?

Financial was the other one that was.

Strong?

Down.

Oh,.

Transportation were down.

Commercial federal and communications were up.

Thank you.

Thank you, John.

Thank you, our next question is coming from Jim Kissane of Bear Stearns.

Please go ahead.

Thanks.

Hate to do this this but just want to follow-up on John's question, larry.

Your services business acted much more like a software company in the June quarter.

Can you give us a sense how much of your services revenue is directly related to software sales?

Say in a given quarter, whether it is your own software or a third party software?

Because I remember you used to talk a fair amount of about repeatable solutions which were much more software oriented.

Jim, our problem in the circumstance was more milestones.

It wasn't software sales.

Off the top of my head, I can't give you the number.

But it is not -- we're not selling the software, we're selling a system with software and integration along with it.

As you know, we do not just sell software, we're not a software company.

But our problem in the infrastructure business on the service side of the business was more related to milestones and not winning -- not closing new contracts.

As I said, we only got one out of the two that were decided that we proposed on in the outsourcing business.

So it isn't -- it wasn't the fact that it was just software that did it.

You can't -- I don't don't think you can find an instance, always be careful in a global company when you say this, but I don't think you can find an instance where we're selling software as a stand-alone, buy a piece of software, and we will record the revenue.

In every case, the software that we create is part of an assignment where the client buys a solution, and the software is an enabler for us to sell them that solution on a competitive basis.

Okay.

Are the infrastructure services margins somewhat higher than the other services line?

I guess excluding core maintenance.

Because it seems like the impact on margins was disproportionate.

Well, I mean, you know, it depends on the job, but, you know, the margins are pretty good.

Core maintenance is better than the rest of the infrastructure.

But you know it is pretty much in line.

Okay and just one last question, Larry or Janet.

The orders, what portion were new and what portion were renewals?

Just trying to get a sense of the incremental revenue from the revenues in the quarter.

John, referring back to Larry's -- I'm sorry, Jim, referring back to Larry's comment, our two large orders in the quarter were the Louisiana Medicaid contract and the Caixa, both of those were renewals of existing relationships with customers that were competitively bid.

Okay.

Can you give us a sense of what portion then was -- was that most of the orders in the quarter?

They were the two largest ones in the quarter.

Okay.

Thanks.

Thanks, Jim.

Thank you.

Our next question is coming from Julie Santoriello from Morgan Stanley.

Please go ahead excuse me, Julie, your line is live.

Why don't we come back to Julie if she's off for the moment.

Our next question is coming from Joseph Vafi from Jefferies.

Please go ahead.

Hi, good morning, and thanks for taking my question.

Larry, maybe just, you know, circle back to the services business, just one more time here, in Q2, and it sounds like there were, you know, a few -- a few things in the way here, maybe some projects not moving forward as fast as you would like.

Maybe that was project specific, versus kind of environment specific, and if you looked at, you know, across the services portfolio there, could you maybe even quantitatively or qualitatively, that is, kind of give us a view as to how much was just maybe, you know, normal project kind of, you know, -- the challenges and moving projects forward, versus how much was potentially a result of maybe clients slowing down work that is actually ongoing, and that might have resulted in some of the shortfall?

Joe, I would say that it is probably 50/50.

I mean, you know, it is always hard to quantify when the client is slowing down.

Or we didn't meet a milestone at a point in time.

As I look at -- at the services business, we hit some of those, and the unfortunate thing was it all kind of hit in the last week or so of the quarter.

And we have never had that.

I mean, I think you know, we have been very consistent in our quarterly earnings.

We've tried to be reasonably conservative in balancing the risks and opportunities, and here, as I mentioned before, you know, the risks came to fruition, and the opportunities didn't.

So I'm not trying to paint, you know, here is one contract that goes away, you know, there were a number of shortfalls, none of which were really that large, and that's why, as I mentioned, I've asked Joe McGrath to take on this additional responsibility now, of looking at this phase of the execution, but looking at it on a very integrated way across our whole portfolio, and we are actually ramping up some new endeavors in that regard, and that's why I said we will probably begin to see the results in the fourth quarter, rather than the third quarter.

We also, as Janet mentioned, and it does hit the operating margin of the service business, we had two events in the second quarter which will run off, as we go to the third and fourth quarter.

One is given the great success that we've had in the federal business, we had to decide on where to put all the people.

We were in multiple locations.

I think it was four, five, six locations.

We brought them all together in Reston.

They were in a single location-- or moving now to a single location, and we have a doubling up of rent in both the second quarter and the third quarter.

By the fourth quarter, it will run off.

We have about 7 million in the third quarter we still have to bite.

And then in the fourth quarter, it disappears.

We also had some other one-time investments.

We did some advertising on a 3D VE and so forth, which we think some of those in particular will one time in the second quarter.

So in the third quarter, you ought to see at least a 7 million rolloff.

In the fourth quarter, about a 14 million rolloff in our SG&A.

Most of which will hit or has hit the services part of the business.

We felt it was important to, in light of the extra costs, to move all of our folks together to make sure that we get the right kind of productivity in the federal business, and therefore, we made the decision.

Again, we thought that had the revenue came in close to where we wanted, we would have been able to absorb it.

But I just want you to understand that there is these rolloffs in the third quarter and the fourth quarter, on the SG&A line, particularly on the G&A line, which will get us back to a better, more favorable run rate.

You know that we've been very tough on our SG&A costs.

And yet, sometimes you have to make an investment, which hits the P&L.

But we thought this was an appropriate investment for us.

Sure.

And then maybe just one follow-up here on switching gear, and going over to ClearPath.

You know, clearly I think we all know the strategy of Unisys and the clear path line is a kind of a replacement upgrade strategy versus the install base.

I mean if you looked at, you know, if you looked at that business, say over the last year or so, and you kind of looked at the competitive landscape for clear path, and, you know, I think there is always a couple of -- you know, there is always a couple of challenge, one is to get the customer to upgrade to the new technology, and then secondly would be to convincing the customer not to -- maybe convincing the customer to switch to a different type of platform away from clear path.

How do you think that strategy is working out and kind of your hit rate and success there?

I guess especially versus maybe people moving to open platforms and away from clear path.

Well, Joe, on the ClearPath, we came out with our new Libra model which I think you're aware of.

We have metering on the Libra model.

But on the metering, you know, there is a base, which is kind of a taker pay, and then you get the metering above the base taker pay.

That has been very successful.

Our sales in that are up about 30% over where they were a year ago.

So we feel very good about the Libra series and what we've been able to do.

On the [droto] series, we expect to have a new offering at the beginning of the fourth quarter, which means we will begin to see some impact in the fourth quarter.

Did it delay some sales in the second or third quarter waiting for the fourth quarter?

You know, conventional wisdom says yes.

I'm not sure.

But the fact is, we feel pretty good from a customer base of what they're doing to do with the droto.

So if you look at year to year, we will be down a few points in clear path, gut is not falling off on the year to year basis, you know, 20%.

There is no question that there is a competitive environment out there but there is also no question that our legacy customers know the quality and dependability and scale ability of our clear path models and they stay with us.

So we're not losing clients.

Now, as they come on to brand new applications, and solutions, you know, that's where we're working with ISVs on the ES7000 line.

As I mentioned, there will be two new announcements which I don't want to get into right now, over the next 60 years in the ES7000.

But at the same time, about 45% of our sales in the second quarter came from ISVs in the ES7000.

So we are working closely with them.

And we still think that we have a good opportunity, because of the capability of operating the ES7000 on a number of different platforms.

All right.

Thanks, Larry.

Thanks, Joe.

Thank you.

Our next question is coming from Julie Santoriello from Morgan Stanley.

Please go ahead.

Hi, sorry about getting dropped before.

Larry, I'm not sure if somebody touched thon in the last few minutes but I just wanted to get your feeling for sort of your level of concern as to the issue of not meeting milestones.

Do you feel that there are certain specific internal execution issues here that need to be addressed?

And if so, can they be addressed within a reasonable amount of time?

Well, first off, I don't know, Julie, if you heard my comment before.

Someone asked, you know, where the milestone issues, your fault, the client's fault, and I said it is probably 50/50.

The answer to your question is yes, we will meet milestones.

There will be client delays, which we can't control.

But the part on our part, there is certainly a very renewed focus, given what we saw unexpectedly in the last week of June, to meet our portion of the milestones.

But let me assure everybody that there will be client delays.

There always have been.

And there will continue in the future.

And those, I'm not giving you the same, you know, yes answer to.

Okay.

And on the BPO side, the pipeline obviously still looks good but I know it has been frustrating in that there haven't been as many signings coming through.

To what do you attribute that?

And kind of in the same vein, you said there was a slowdown in the financial services business which has been very, very strong for Unisys in the past year, I guess.

Are you hearing of any particular change among financial services customers?

Well, first off, in the BPO business, we look at -- at a lot of deals, Julie, and in some situations, we find competitors wanting to get into the BPO space.

They don't necessarily have a solution.

But they think that price is the answer.

And we're more than happy to let them do that.

We're not going to chase some of the pricing that is going on in certain pieces of BPO, where people want to break into the market.

Now, they have -- those contracts haven't been let yet.

But we've made it be known, as we have said before, that our goal is profitable deals, and they got to be win-win.

I am disappointed that we haven't closed some of the big ones.

I've been out on the road in the last month, and Joe and I will be over the next several months, visiting some of these large clients.

I've actually got one tonight that I'm meeting with, where we're really talking to them about are they serious, are they going forward?

What is holding them up.

Now, when you look at the financial services, which has been the biggest part of BPO and outsourcing, I think, and this is a personal observation, they're not saying this directly to me, but I think that the whole level of M&A activity and the excitement around what's going to happen particularly with consumer banking, and everybody is looking at everybody else from an acquisition standpoint, has slowed up -- we know it has slowed up Check 21.

And I think it has just kind of put people into the mode of, if I get my earnings up and don't spend any money, maybe I can protect myself, or if I'm not protected I will get a higher price.

So, you know, should I control the spending.

That's my analysis.

On the Check 21, they've told us.

On the other part, I'm guessing but given all the noise, and you know, that's been written about what's going on, and it seems like every week, there is a new announcement or a new rumor, I should say, rather than an announcement of whom is going to by buy whom.

I think this slows down decision making, in the financial service industry, particularly the banking part of the business, and the insurance part of the business, but the banking, which is a large part of our practice.

Okay.

And just to be clear that I understood your Check 21 comments from before, I understand that you said there has been opportunity sometime in 2005, I think the feeling last time we spoke was some of the signings could still come through by the year-end '04.

Is that still reasonable?

Yes, it is reasonable.

But the revenue from those signings is more like 2005.

We originally thought that by the second half of 2004, that had it not been for some of the M&A activity that we would have begun to see some of the revenue coming in.

We continue to do lots of studies.

We're doing some very interesting 3D VE workshops with commercial banks, where we're actually helping them through the whole process of what has to be done, and what are the implementations.

This work is ongoing.

But it is project based.

It isn't the BPO kind of work that we're trying to get in Check 21.

So that's kind of how we see it right at this moment.

As you know, Check 21 isn't going away.

And it is going to be a global event.

But it is not moving as fast as we and everybody else had anticipated.

Okay.

Thank you.

Thank you, Julie.

Thank you.

Our next question is coming from [Peter Labay] of Nutmeg Securities.

Please go ahead.

Thanks a lot.

Larry, I'm still struggling a little bit with some of the reasons here.

Isn't it kind of overwhelming that there is an industry wide hesitation in the marketplace, and in your orders back in July, doesn't that signal a -- maybe a change in industry dynamics looking forward?

Or am I trying to read too much into too little?

Peter,, you know, I said there is no broad based cause, and the reason why I'm not ready to declare whether it is an industry problem or not an center problem is when I look at our pipeline, our pipeline is strong.

The number of BPO deals that we're looking at, the number -- and I'm just talking about services now.

The number of systems integration deals.

When we look at technology in the second half of '04 versus the second half of '03, you know, we're seeing something that looks comparable in revenue dollars.

So I don't think it is industry wide.

Now, as I mentioned before, I'm kind of giving you a view from me rather than from a whole bunch of clients because this thing just happened to us very late in the quarter.

When I look at all the software companies that have announced and other than just software, some service companies and others, you know, there seems to be a lot of noise in the system right now in technology.

The intel results, which I thought were very good, were rather surprising when we saw the market reaction.

So I think, you know, we probably got another 60 days to really see if others are experiencing this.

I will tell you that as we look at our pipeline, the pipeline is there.

The reason we took our numbers down for the second half of the year is to be realistic because some of these BPOs are taking longer to close.

And we do know from industry sources that all all of the outsources and VPO and IPO is taking longer to close, and there are a lot of deals on the horizon, they tend to be smaller piece, and the clients are breaking them up into pieces instead of keeping them in one big package and this is slowing down the process.

So I'm not ready to move to hey, we've got a similar slow down similar to what we had in 2000, but I think there are some dynamics that have to be watched here.

Thanks a lot, Larry.

That makes it a lot more clear.

Thank you, Peter.

Thank you our final question is coming from Julio Quinteros of Goldman Sachs.

Please go ahead.

Good morning.

Janet, I was wondering if you could just elaborate a little bit more on the earnings expectations for the next quarter?

Specifically because when I look at this quarter, it looks like you have about $24 million of for ex gains.

What she would expect as a percentage of the earnings expectations for next year that will come from other income?

Julio, you know, that other income line can vary plus or minus $20 million in any given quarter.

Our expectations, as we go into next quarter for that to be a minimal amount right now.

So you're forecasting it to be a flat contribution or relative to the second quarter or do you mean --

No, obviously the second quarter at 24 million is at the very high end of that category ever gets to.

Last year, in the third quarter, our other income was a loss of 4.7 million.

We expect it to be better than that probably about the flat level right now.

Okay, so down quarter over quarter most likely.

Yeah.

Okay.

And then as it relates to your comments with regards to expenses, I know that we had talked about this a couple of weeks ago, but can you elaborate a little bit about the incremental expenses with Sarbanes-Oxley?

I think you said that was about 50% of the increase in your SG&A line?

Let me clarify.

What I said was about 50% in the increase in the SG&A was attributable to the currency impact year over year.

And the remainder, primarily relates to the costs of the move of our federal operations into their new headquarters building in Reston and a portion of that remains related to the one-time charge for the documentation and testing and reporting related to the internal control requirements in Sarbanes-Oxley.

From a timing standpoint, this is a very -- the second quarter was a very key quarter for us.

It is when we finished doing our documentations, start to overlap to have our external auditors Earnest & Young begin their testing.

So that's why we -- that was the reason we called that out for a bump.

There was not anything unusual in what we did.

It it is just the Sarbanes-Oxley require to you document and to test globally the internal controls.

An it was the expense related to that.

And why would you consider that a one-time expense?

I mean Sarbanes-Oxley doesn't go away at any point in time.

Sarbanes-Oxley didn't go away for the internal control requirement but there is a first time effort related to the internal controls which requires every company to go through, identify the strategy of how to view the controls in response to the regulations, and in that case, we have had an outside consultant helping us develop the strategy.

You have to then come up with a documentation that is consistent with the Sarbanes-Oxley requirements.

That is for a one-time effort to start that documentation.

And then you have to do the training, globally, deploy and test that globally.

What you will continue to have on an ongoing basis is the testing and the reporting requirements, but this upfront piece of the strategy, the documentations, the training, and the initial testing is a one-time event that occurs -- that increases your expense in this year, for Sarbanes-Oxley.

Okay.

And then on the pension expenses, in the third quarter, did you -- you said 8 to12 cents excluding pension?

Did I miss the earnings after the pension expenses?

It is a nickel.

A nickel.

For pension.

Okay?

Okay.

You also see that that is on the investor website.

To make sure that you've got that clear.

Got it.

Okay.

And then finally, on the operating cash and free cash flow, I know that, you know, we're still probably too far away from being able to have a sense, but can you give us a sense, we're looking now at 50 million in free cash flow for calendar year '04.

I mean what kind of growth should we anticipate as realistic in calendar year '05 in free cash flow?

Julio, I want to just make sure that I'm clear on the free cash flow expectation for '04.

It is 50 million plus.

And we haven't yet given any guidance for '05 on free cash flow.

Okay.

Great.

Thank you.

Thanks, Julio.

Thanks, Julio.

And you know, I just want to conclude this by one, thanking you again for giving us an opportunity to talk to you about the second quarter.

And also, again, express the disappointment of the entire team of what happened in the second quarter.

We appreciate your support.

And we hope we can continue to have your support.

These things happen.

We are committed to get out from under.

We don't think that this is a systemic problem at Unisys.

But we did have a short fall in the second quarter.

And that is factual.

So you can be assured that every one of us is doubly committed to moving forward, and making sure that we overcome this.

And we meet the forecasts that we have put forward in this phone call and in our press release.

Joe McGrath and I are meeting on business television with all of our employees, in about 30 minutes to take them through some of the initiatives that we are moving forward with.

So I want to assure you that this is something we take very seriously.

With that, again, thank you all for listening.

And bye bye.

Thank you.

That does conclude today's teleconference.

You may disconnect your lines at this time.

And have a wonderful day.