Unisys Corp (UIS) 2004 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Unisys fourth quarter and full-year 2004 results of his call. At this time, all participants have been placed on a listen only mode and the floor will be open for your questions following the presentation.

It is now my pleasure to produce your host, Mr. Jack McHale. Sir, the floor is yours.

Good morning, everyone, and thank you for joining us. About an hour ago, Unisys released our fourth-quarter and full-year 2004 financial results.

With us this morning to discuss our results are Unisys President and CEO Joe McGrath and our Chief Financial Officer Janet Haugen and also joining us is our Chairman Larry Weinbach. Joe and Janet will have some opening comments this morning and then we will open the call for Q&A.

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 website shortly after the conclusion of the live event.

Second, please note that certain financial comparisons made in this call will be with and without the impact of pension accounting. We believe this provides this non GAAP information as meaningful to fully understand our operating performance because while pension accounting is non operational in nature, it does impact our reported results.

On the investor website, we have provided a reconciliation of our reported results on a U.S. GAAP basis, compared with our results excluding the impact of pension accounting.

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

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

Today's presentation, which is complementary to the earnings press release, includes some non GAAP financial measures. Reconciliation of these measures to GAAP results are available in the earnings release or our website for viewing and downloading.

Finally, I would like to remind you that all forward-looking statements made in this conference call are subject to various risks and uncertainties that could cause actual results to differ materially from 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 Unisys's investor website. With that let me now turn the call over to Joe.

Thanks, Jack, and hello, everyone. Welcome to today's call.

To begin our discussion this morning please turn to slide one for an overview of our results for the quarter. This was a challenging quarter for Unisys. As we indicated in our released two weeks ago our fourth quarter results came in below our expectations and the asset impairment charge caused us to report a loss for the quarter. There were two main factors that impacted our results in the fourth quarter.

First, we saw without weaker than expected technology sales late in the quarter. Second, we continue to be impacted by the challenges in a few large transformational outsourcing contracts. These two factors, in addition to pension expense, were largely the reason for the year-over-year decline in our full year 2004 results.

Let me share with you that on these challenging outsourcing engagements we are meeting our clients' expectations and service levels. Most importantly these clients continue to be references for us in the market.

Overall, the 2004 results were deeply disappointing for all of us at Unisys. Major corporate transformations such as this one that we have been undergoing at Unisys do not happen in a straight line. But we have learned some tough lessons and we plan to capitalize on those lessons to improve our performance going forward. We have some challenges ahead of us as we expect some of the weaknesses in the fourth quarter to continue into the first quarter of 2005.

However, we remain committed to the transformation in the services led strategy we have been pursuing. We believe that we have an opportunity to become a top tier solutions provider in the IT industry and we are confident we can get there.

In my remarks today, I will discuss our priorities over the short and long term to drive profitable growth and enhance shareholder value. As you see, we are taking specific, concrete, and far-reaching actions to drive the kind of execution and culture change needed at Unisys to achieve a leadership position in our industry.

First, here is Janet to review the fourth quarter and full-year 2004 financial results and to provide an outlook for 2005.

Thanks, Joe, and hello everyone. This morning, I will discuss the factors that impacted our results in the fourth quarter and I will also update our financial outlook for 2005.

First, for a summary of our results in the fourth quarter. At the top line, we reported revenue of 1.52 billion for the fourth quarter of 2004 which was down 7 percent from the year-ago period. Currency had a 4 percentage point positive impact on our revenue in the fourth quarter, reflecting the weakness of the dollar against international currency.

Turning to slide 2. At the bottom line, we reported a fourth quarter loss of $35 million or 10 cents per share. Our fourth quarter 2004 loss included three significant items.

First, we took a pre-tax non-cash charge of $126 million or 26 cents per share to write off capitalized assets associated with the challenging transformational outsourcing operation that we discussed at our December 7th investor community meeting. Second, we recorded an after-tax benefit of $29 million or 9 cents per share, principally due to the favorable settlement of income tax audit issues in the quarter. And third, we continue to be impacted by pension accounting. We incurred $23 million of pre-tax pension expense or 5 cents per share in the fourth quarter compared with $200,000 of pension expense or zero per share in the year-ago quarter.

Without those items, we had a shortfall of about 20 cents per share in the quarter, compared to our earlier expectations.

Slide 3 outlines the key factors behind the earnings shortfall in the quarter. About 8 cents of the earnings shortfall was due to the booking of a large complex contract that we signed in December. This is a multi-element contract involving hardware, operating system software, and services. We had anticipated that we would book the revenue and profit on the hardware and software elements in the fourth quarter as the equipment and the software was delivered and accepted by the quarter.

However, based on the final contract terms and conditions, the appropriate treatment was to book revenue on a month-to-month basis over the five-year term of the contract. This treatment does not change the economics of the deal or the total expected revenue, profit, or cash flows of this contract.

The remainder of the shortfall in the quarter -- about 12 cents in earnings -- came primarily from two areas. First, we saw lower-than-expected technology deal closure late in the quarter, particularly for high-end enterprise servers; and, second, in the services business, we were impacted by the continuing challenge of some of our transformational BPO contracts.

I would like to now provide more details on the fourth-quarter results. To start, I will review orders in the quarter and please turn to slide 4 for an overview.

Overall, our orders in the quarter were basically flat compared to a year ago but down on a constant currency basis. Services orders were up slightly versus a year ago. Excluding outsourcing orders which as you know can vary significantly from quarter to quarter, services orders were up high single digits in the fourth quarter. Technology orders showed low double-digit declines.

We ended 2004 with 6.78 billion of services backlog which was up 6 percent from year-end 2003. In addition, we ended 2004 with 2.36 billion of unfunded U.S. government orders.

Now moving to revenue in the fourth quarter, please turn to slide 5 for an overview of our fourth-quarter revenue by geography. Our U.S. revenue declined 10 percent and represented 44 percent of our revenue in the quarter. Revenue for international regions declined 4 percent and accounted for 56 percent of our revenue in the quarter.

Turning to slide 6. Technology revenue declined 21 percent in the quarter and accounted for 18 percent of our total revenue. We did not achieve as large of a fourth quarter bounce in technology revenue as we had in prior years; and, additionally, as I mentioned earlier, we had anticipated that we would book a significant technology deal to be recorded as revenue in the fourth quarter. But we were unable to book the revenue, based on the final contract terms and conditions.

Turning to slide 7. Our services revenue declined 3 percent in the fourth quarter, with declines in each of our services segment. Services represented 82 percent of our total revenue in the quarter. Within all services, our segments declined low to mid single digits in the quarter.

Moving to our full-year 2004 results. I would like to summarize our full-year 2004 revenue and how it breaks down by geography and business segments. Slide 8 shows our full-year 2004 revenue by geography. Overall, our 2004 revenue declined 2 percentages from full-year 2003 revenues. Currency had a 4 percentage point positive impact on full-year 2004 revenues. Our U.S. revenue declined 4 percent in 2004 and represented 45 percent of revenue for the year. International revenue grew 1 percent in 2004 and accounted for 55 percent of our full-year revenue.

Slide 9 shows our full-year 2004 revenue by business segment. Services grew 1 percent in 2004 and represented 81 percent of our total revenue for the year. Technology revenues declined 10 percent in 2004 and accounted for 19 percent of our revenue for the year. Drilling down into our two business segments, slide 10 shows our full-year 2004 services revenue by component.

Systems integration and consulting revenue grew 4 percent in 2004 and represented 35 percent of our services revenue. Outsourcing revenue grew 3 percent and accounted for 37 percent of our services revenue. Infrastructure services declined 8 percent in 2004 and represented 16 percent of our services revenue.

Finally core maintenance revenue was flat in 2004, accounting for 12 percent of our services revenue.

Moving to slide 11. In our technology segment, enterprise server revenue declined 6 percent in 2004 and accounted for 79 percent of our technology revenue. Within enterprise servers, sales of ES7000 servers were up low double digits for the year while ClearPath revenue showed high single digit declines for the full year of 2004.

A brief note on expense trends in the fourth quarter. SG&A expenses, excluding pension in both years, represented 17 percent of revenue in the fourth quarter. Flat from the year ago quarter. R&D expenditures, also excluding pension expense, represented 5 percent of revenue and relatively flat with the year-ago levels.

Slide 12 shows our operating margins excluding pension accounting in both quarters. Excluding the impact of pension expense, our fourth-quarter operating margin was 3.6 percent negative in the quarter down from 9.7 percent a year ago. This decline was principally due to the asset impairment charge.

Slide 13 provides a comparison of the services operating margin in the quarter. Excluding pension accounting, we had a negative 7.8 percent services operating margins in the fourth quarter of '04, compared to 7.5 percent in the year-ago quarter. This decline was again principally due to the asset impairment charge.

Moving to slide 14. In our technology business, we achieved a 12.8 percent operating margin, excluding pension accounting in the fourth quarter of 2004. This compared to a technology operating margin of 13.6 percent in the fourth quarter of 2003.

A few other notes. In our income statement in the fourth quarter of '04, in other income and expense, which can vary from quarter to quarter, we reported 6.2 million of other income in the fourth quarter of 2004, compared to other income of 19.9 million in the fourth quarter of 2003. The principal reason for the change was foreign exchange gains in the year-ago quarter, compared to foreign exchange losses in the fourth quarter of 2004. Now, please turn to Slide 15 for a view on our cash flow and balance sheet highlights.

We generated $227 million of cash from operations in the fourth quarter of 2004. This was down from $378 million of operational cash flow in the fourth quarter of 2003, primarily due to the lower income. For the full year of 2004, we generated $470 million of cash flow from operations. Total capital expenditures in the fourth quarter of 2004 were $123 million, slightly up from $119 million in the year-ago period.

For the full year of 2004, capital expenditures were $434 million, compared to $437 million in 2003. After deducting capital expenditures, we generated $104 million of free cash flow in the fourth quarter of 2004 and $36 million of free cash flow for the full year of 2004.

A few other notes on cash flow in the balance sheet. Depreciation and amortization was $109 million in the fourth quarter of 2004 and for the full year of '04 D&A was $394 million.

Looking forward, our expectation for capital expenditures for the full year of 2005 is in the $365 to $380 million range. We expect depreciation and amortization to be in the $360 to $370 million range and we are targeting more than $50 million of free cash flow in 2005.

We ended 2004 with no borrowings against our revolving credit facilities and $661 million of cash on hand. On January 18, we repaid at maturity all outstanding balances on our $150 million of our 7 1/4 senior notes. This repayment was made from cash on hand and reduced our long-term debt to approximately $900 million.

In the first quarter of 2005, we expect to receive the U.S. government tax refund of about $40 million related to the third-quarter U.S. tax audit settlement.

Finally, let me give you a quick update on cost reduction actions that we announced in the third quarter. Of the 1400 position reductions that we announced, we have completed about 500 and we expect to essentially complete these reductions by the end of the second quarter of 2005.

We expect these cost reduction actions to be basically neutral for 2005; and we expect the actions to require about $65 million in cash in 2005. But this cash usage will be offset from the proceeds of the U.S. income tax refund as well as expected cost savings from taking the action.

Moving to slide 16, I would now like to provide an update of our pension accounting for 2005. As you recall, our U.S. pension plan accounting assumptions for 2004 were an 8.75 expected long-term rate of return and a 6.25 discount rate. Our actual return on U.S. pension plan assets -- which is based on our asset allocation strategy in the performance of the equity market -- was about 13 percent in 2004.

For the U.S. pension plan in 2005, we are again assuming an 8.75 percent expected long-term rate of return on our assets. However, based on the December 31st, 2005 long-term interest rate environment, we are reducing our assumed discount rate on our U.S. plan to 5.88 percent. Based on these and other actuarial assumptions, and including our international defined benefit plans, we expect approximately $186 million of pre-tax pension expense in 2005 compared to $94 million of pre-tax pension expense in 2004.

From a cash perspective, we expect to contribute about $70 million of cash, primarily to our international pension plan in 2005. That compares to our cash contributions of about $63 million in 2004. We made no cash contribution in 2004 to the U.S. qualified plan -- our largest defined benefit plan -- and no cash contribution is required for this plan again in 2005.

Let me move on to stock options. As you know, in December the FASB issued the new rule requiring the expensing of stock options. The Company expects to adopt this statement on July 1st, 2005, as permitted by the rules.

We have not yet completed the full impact of this new rule on the results of our operation. However, based on the pro forma results that we have been reporting, the effect on the earnings per share would have been 10 cents in 2004 compared to 15 cents in 2003. Based upon the Black-Scholes model used to calculate the pro forma FX, we currently estimate that impact would be 8 cents per share for the full year of 2005.

Obviously, the final results will vary as we finalize our analysis of the option pricing model used to price the Company's stock option.

Let me move into our financial outlook. Turning to slide 17, I would now like to update our financial outlook going forward. As we look at the first quarter of 2005, we expect to continue to be impacted by some of the challenges we faced in the fourth quarter. In particular, we expect three factors to impact us in the first quarter.

First, as Joe mentioned, we will continue to be impacted by certain large transformational outsourcing operations, including the operation where we took the asset write-off in the fourth quarter. As we mentioned in December, the challenge from these contracts will continue to affect our results in 2005.

Second, we expect continued softness in our ClearPath business in the first quarter as general IT spending conditions remain weak in our high-end market for the large multimillion dollar enterprise server sales.

Third, as we announced in December, we expect there to be some doubling up of costs in the first half of 2005 as we implement our cost reduction program before we began to see the benefits of these actions in the second half. As I mentioned earlier, our free cash flow target for 2005 is $50 million plus.

Now I'd like to turn the call over to Joe for more discussions on the business.

Thank you. As I mentioned at the beginning of Mike comments, we are committed to taking the necessary steps to drive improved results going forward and I would like to discuss these actions with you.

Please turn to slide 18 for a summary of these initiatives. Broadly speaking, we are taking action on three fronts.

First, we are working aggressively to fix the challenging contracts in our outsourcing business and to drive improved execution and delivery going forward. Second, we are driving programs to grow the top line with particular emphasis on outsourcing and enterprise servers. Third, we are executing a detailed program -- announced in the third quarter -- to take out 70 million of annualized cost from our business and enhance our efficiency. This is critical to getting the leverage we need and to achieve our operating margin targets.

Let me take you through each of these initiatives. Please turn now to slide 19. Our first initiative is fixing the issues in our business process transformation outsourcing engagements. As you know, in the second half of 2004, we encountered execution issues in several of our business process outsourcing engagements. We identified two of these challenging engagements in the third quarter and we discussed a third one at our December 2004 analyst meeting.

Let me give you a sense of what happened on these three outsourcing contracts. They are all large complex BPO engagements with a significant transformational element. That is, the contract involves transitioning from the client's old environment to a new state-of-the-art environment with new processes and software. In each of these cases we underestimated the amount of time and related expense needed to complete this transaction to the new environment. It has taken us longer to create the new software and transition to the new processes; and this has resulted in higher-than-expected costs on the contracts, not only in terms of creating the new technology and processes but also in the people cost involved in the old operation.

So these were execution issues. Issues of properly bidding, scoping and delivering these projects on time and on budget. We were relatively new to the transformational BPO space at the time we won these contracts. We have learned some hard lessons. We are taking aggressive action to fix these execution issues. We have changed the management in all of these operations. We have upgraded the skills of the people at all levels who manage and deliver these projects. We have put our top performers on the ground to manage these operations and put in place improved processes. We have made changes to strengthen our proposal bid and review practices. We have placed entire scrutiny over bidding procedures to ensure we win deals we can deliver on and profit on. We have gotten top operating management of the Company, including myself, involved in large deals from the time of the initial bid through the ongoing management and delivery to the client.

Our senior operating management is now reviewing all services bids greater than 30 million in value. That is compared to 100 million in the past. I believe these initiatives will make a dramatic difference in our ability to execute and deliver in our outsourcing business.

But let me note. We are not having day-to-day operational problems with these contracts. We are meeting the service level agreements and achieving the cost efficiencies our clients expected. And they continued to be references for us. Our challenges have been in the delays on development of new software and the resultant change management around the implementation of the new software and transformed processes and this is leaving the higher cost to us on the contract.

Because of these challenges, we have become conservative in pricing new business and you have seen this impact in our 2004 orders. Let me also add that Unisys remains committed to the outsourcing business. Outsourcing is the fastest growing of the IT services industry and with our end-to-end services portfolio and vertical industry focus, Unisys has the right capabilities to succeed in this market. We have a number of significant opportunities in our pipeline and we expect to see orders pick up as we go through 2005. We believe this will allow us to return to our outsourcing business to an appropriate growth profile in the second half of 2005.

Turning to slide 20. Our second key focus area is to improve the top line. To grow our orders and revenue. There are a number of initiatives we are pursuing to grow our top-line revenue. The first is in the area of sales excellence. We are reengineering our sales process and how we manage our top accounts. We have built dedicated cross-business unit teams to serve our top 50 accounts and bring the full portfolio of Unisys services and solutions to these clients.

Our goal is to significantly grow our revenue from these top accounts. We have already implemented this program at selected client accounts with compelling results. For example, with a large U.S. federal government client, we have grown our annual revenue to more than $90 million from $45 million over the past three years.

We have created a new one Unisys sales compensation program that focuses on enhancing cross selling among our largest clients. This program will then send people at all levels from our salespeople to our sales management to our senior executives to work together to win new business, regardless of where the business falls within the organization. The goal is to increase our win rates, enhance sales productivity, and drive orders and revenue.

We are also focused on improving our delivery excellence in the field. We are building a common set of delivery processes across every industry and every business unit of the Company. This new resource management system combined with expanded global methodologies will allow us to use our best people and talent and engagements regardless of where these people reside in the Company. We are breaking down silos and allowing our delivery groups to act as one organization. The goal is to improve the quality of delivery and enhance our success with customers.

Turning to slide 21. In addition to these operational improvements, we are also focused on driving growth to enhance marketing of our portfolio of services and technology. Our marketing efforts in 2005 will be focused on marketing our 3-D Visible Enterprise Methodology and Solutions. This will be key to driving new revenue and new clients.

We believe 3D-VE is a unique offering in today's marketplace. Many of our competitors are talking about offering such capabilities but right now we believe Unisys is the only provider in the market with a full end-to-end solution. As a result, we have a window of opportunity and market with 3D-VE and we are taking advantage of that opportunity. We have rolled out 3D-VE worldwide and continue to see strong interest in it from our clients. So far, we have won more than 60 client engagements with 3D-VE as an integral component. These engagements are valued at nearly $700 million and include wins from such marquee organizations as ING, PepsiCo, Toys R Us, Qantas and Virgin.

We continue to run experiential workshops to introduce 3D-VE to prospects. We have conducted more than 40 workshops to date and we have another 80 workshops in the works. We have a significant pipeline of business that we are pursuing for 3D-VE. We are working on more then 200 potential 3D-VE market opportunities, valued at several billion dollars. And the pipeline continues to grow.

Security will be another key area of marketing focus for 2005. In nearly every industry survey of IT spending trends, security comes out at or near the top of client spending intentions in 2005. Unisys has strong capabilities in security and we need to convert these into business opportunities for order and revenue growth. We believe our strongest near-term opportunities in security are in the Federal market where we are leveraging our success in our contracts and pilot projects with the Department of Homeland Security and the Transportation Security Administration.

Looking to 2005, we will be pursuing opportunities with DHS and TSA in the areas of IT infrastructure consolidation, cargo security, and identity management. In the commercial area, we see opportunities with shippers, pharmaceutical firms, and consumer product companies in the area of secure supply chain. This is the market for tracking, tracing, and securing goods and assets.

Since launching our global visible commerce family of supply chain solutions in the fall, we have seen our pipeline of potential opportunities continue to grow. We see this commercial market developing gradually over the next few years, starting with our pilot projects and moving into broader-based implementations. Our work with shippers and seaports in the operations safe commerce pilots is a good example of these pilots.

Another example is our work with GE. Last fall, Unisys served as a systems integrator in a supply chain pilot project involving GE, Unisys, and China International Marine Containers. This project tested experimental secure containers using integrated security devices that detect container breaches and provide shipment visibility. There are some 16 to 19 million shipping containers in use today and tamper-evident containers are expected to begin hitting the market over the next few years.

Experts expect such smart containers to grow in usage over the next decade and we are pleased that we are at the cutting-edge of research and testing in this area. We see securities as a major growth opportunity for Unisys. This market is still developing and we don't expect a dramatic increase in our business right away; but our reputation in security continues to grow and we are enthusiastic about this market and our growth prospects.

Turning to slide 22, in our technology business we will be focused on expanding volume in our enterprise server business, especially sales of the Intel-based ES7000 servers. In our ClearPath program, we are focused on satisfying our client base and helping our clients expand usage of their ClearPath systems by offering modern leading-edge tools and capabilities.

In 2004, we rolled out a new generation of ClearPath products with leading-edge functionality. For example, clients have responded well to the new pay for use or metering capabilities that we introduced on ClearPath in 2004. These capabilities allow clients to pay for performance on an as-needed basis.

Also in late 2004, we introduced our application modernization service which is based on our 3D-VE methodology and includes support for open standards such as J2EE and Microsoft.net. This program allows clients to modernize their legacy applications and gain leading-edge functionality without having to sacrifice their investments in legacy applications and incur the high cost of migrating to new platforms.

In 2005, we will actively promote and market these capabilities for greater penetration among our client base. Most of our clients have not yet availed themselves of these new functions, so we believe this is an opportunity for us to drive ClearPath sales and help customers find new uses for their ClearPath systems. We expect 2005 to be back end loaded for ClearPath.

After a slow first quarter we expect sales to improve through the year and with the new models and features that we are offering, we expect this will help us hold ClearPath to a revenue decline in the low to mid-single digits for 2005. In our ES7000 program, we were not satisfied with our sales performance in the fourth quarter. For the full year of 2004, the ES7000 program showed low double-digit revenue growth. But this was still below our expectations.

In 2005, we are focused on driving stronger growth in our ES7000 program. First, we will continue to drive sales of Windows-based ES7000 servers. This has been the primary market for our ES7000 servers and we want to continue meeting the needs of this market with leading-edge products and functionality.

Second, we will target the high-end enterprise Linux market with a new sales market as a new sales market for the ES7000. We expect the enterprise Linux market to continue to emerge rapidly and this is a major potential new market for the ES7000. We plan to attack it aggressively.

Third, we are making a major push to market and sell optimized infrastructure solutions for the ES7000 for the Windows and Linux markets. Rather than focusing solely on the superior technological advantages of the platform, we will develop and market horizontal solutions on the ES7000. These solutions will make use of Unisys and third-party services and applications in the focus will be on selling the entire solution to clients to meet their needs in these areas.

By focusing on solutions, we believe we will further differentiate ourselves from the commodity technology vendors in the Intel-based market.

In support of these initiatives, we will introduce new models of the ES7000 in the second quarter that utilize the newest generation of Intel chip technology, running the Windows operating system as well as Susa (ph) and Red Hat Linux. We will also have new value-added capabilities with our Sentinel Management Suite of products. With these new models and initiatives, we believe we can grow the ES7000 sales by more than 25 percent in 2005.

Moving to slide 23. Our third major initiative in 2005 is to continue reducing our cost structure. In recent years, we have done a great deal to reduce our cost space. But especially in this industry with the level of competition that we are facing, it is critical that we continue to drive down costs and improve our efficiency. We continue to take steps to reduce expenses such as the administrative expense reduction actions we announced in the third quarter, which will give us 70 million of annualized cost savings on a run rate basis by the end of 2005.

Our specific goal in 2005 through these and other actions is to reduce our SG&A, excluding pension expenses, to under 17 percent of revenue on a full-year basis. But I believe we need to take this effort to the next level.

That is why I have initiated a Six Sigma program at Unisys. We call this program Six Sigma Lean because the purpose is to create a highly efficient, lean organization that is based on discipline and focused execution. Six Sigma Lean is a multi-year program that will use common tools, processes and methodology to create a data-driven, performance-based culture at Unisys. The program is focused on enhancing productivity by driving out waste and redundancy and improving the quality, cost, and time performance of the business. The program is designed to assure that quality goals are integrated into the business and every initiative and activity is focused on delivering value for our customers; and that performance metrics are clearly and closely tied to the business objectives of the Company.

The goal is to create a breakthrough performance through the commitment to total quality and discipline execution.

We have recently kicked off a Six Sigma Lean program at Unisys taking it to our top management and field sales and delivery force. Over the next few years, we will progressively introduce the program to all of our 37,000 employees, making sure that everyone is part of the disciplined culture that we are creating. This will be a major effort, but I believe it is critical to taking us to the next level of success in the marketplace.

Turning to slide 24. In summary, we are taking concrete actions to drive profitable growth, both in the short term and long term. Throughout the year, I will discuss our achievements against these initiatives. While in early 2005, we have some challenges, I'm optimistic about our prospects for returning to earnings growth, particularly in the second half of the year. I know my team is optimistic as well. We are committed to getting these problem contracts behind us while continuing to grow and improve our other services businesses and managing the transition in our technology business.

Now I'd like to turn it back to Janet.

Before going into the Q&A, let me reiterate our financial outlook going forward. As we look to the first-quarter 2005, as both Joe and I have mentioned we expect to be impacted by some of the challenges we face in the fourth quarter. In particular, the three.

First, the impact of the transformational outsourcing operations; second, the continued softness in the ClearPath business in the first quarter; and third, the double lining up of cost in the first half of 2005 as we implement the cost reduction programs before we see the benefit of these actions in the second half.

For these three reasons, we are looking for a slow start in the first half of 2005. We look for earnings per share in the first quarter of about breakeven to down slightly, excluding pension accounting. We expect revenue in the first quarter to be slightly down year-over-year. We look for our revenue for the full year of 2005 to increase in the low- to mid-single digits from 2004 levels. Based on today's rates, we anticipate the currency will have around a 2 percentage point positive impact on our first-quarter 2005 revenue comparison.

Because of the weak first quarter, we are revising our prior earnings guidance for the full year of 2005. We now look for earnings per share of between 50 and 60 cents, excluding pension expense and the impact of stock option expensing, for the full year of 2005. And we look for free cash flow of $50 million plus.

Now I will turn it over to Jack for the Q&A session.

Thank you, Janet and Joe. Operator, we are now ready to open up the lines.

(OPERATOR INSTRUCTIONS). Julie Santoriello, Morgan Stanley.

Joe, can you talk a little bit more about the problem contracts in terms of how they are spilling over into the first quarter? Specifically, how confident are you that the problems there will be over in the first quarter? Where are the steps that you are taking more specifically on these contracts?

Thank you, Julie. In terms of what we expect on these problem contracts through the entire year 2005, frankly, we really see some of the issues not just continuing into the first quarter but into the first half. So that is why it has affected our full-year outlook; and we have traced a number of these for you, I guess, over the last couple of quarters. The first one we actually did renegotiate with our client; and although it is not in the profitability state we would like, it is a very stable contract and we are very comfortable with it.

The biggest one is this most recent one which was actually the result of the asset impairment write-off. And despite the write-off, that still remains a problematic contract for us. So we see that carrying through for the first two quarters of the year and still having some residual effect on the second half of the year.

The kinds of things that we are doing is as you have heard in every one of our problem contracts, we changed the entire leadership team across that contract. In many cases, we have had a requirement for the infusion of new skills, specifically in the areas of change management and business process re-engineering, which were two of the most significant skill gaps which resulted in some of our issues. And we have done that.

But that said, these are still extremely complex re-engineering contracts; and it is not just the introduction of the new software. It is that, in conjunction with the re-engineering of the process that allows us to let go the resources that were part of the original engagement. And so we would love these to be, love us to be able to work through these in a more aggressive way? But there is a series of interdependencies in the area I described.

The new software is available, tested, the process is reengineered. Again there is all the associated change control around that and change management. And finally we are able to continue to reduce on an ongoing basis the resources that we often inherited from the original engagement. In almost all of these cases, they have taken longer than we expected and at the top of our Company in every one of days these, Janet, myself, Larry and sometimes other officers are involved in list managing these on actually a week-to-week basis to work our way through them.

So it has been unfortunate. It has been painful. There's been significant lessons learned. We still see an issue with them through the full first half; and we expect to see more aggressive recovery in the second half of this year.

Thanks Joe and if I could just ask you a little bit more about the cost reduction programs that you discussed in detail. There seems to be a lot going on in that regard and clearly a lot of attention on it. Is it possible that -- have you identified opportunities? Ways you can get the cost savings beyond $70 million in '05?

Yes. That is the primary reason, Julie, for the whole Six Sigma program. We believe that our market will get increasingly competitive over time, because of two major trends. The first is the open source movement which, on one hand in the technology business, we hope to take advantage of; but that puts pricing pressure on the entire technology segment. We believe that is not going away. I don't know if you have carefully watched it, but the major research universities throughout the United States have made commitments to completely convert both the research side, the actually education and curriculum side as well as their own infrastructure to Linux.

That is a great opportunity for us on the technology side. But, as more and more of the proprietary technology business goes to open source, it becomes an extremely competitive pricing environment. We hope that is in our advantage and we plan to be aggressive there, but it puts pricing pressure on everyone, especially all of the proprietary suppliers.

The second major issue that puts tremendous pricing pressure on this is global sourcing. As you well know that that is continuing to accelerate over time, as you also know, it began in India but we are seeing it reaching further and further into Central Eastern Europe, China, and the rest of the world. The good news is we have resources in low-cost countries around the world and a significant number of our resources there. We also have an operation that we continue to ramp up in India; but that said, that will put continued price pressure on rates and margins in the services business.

So the reason Six Sigma was so important to us is, we believe this race around pricing pressure on both sides -- technology and services -- is, frankly, a race without a finish line. It is about continuous improvement and it is about continuing to take costs out month by month, quarter by quarter forever to be competitive in this industry. So we believe we will be -- never done that.

The good news is we have already recruited a number of "black belts" as the foundation of our Six Sigma program. We are going to be very targeted there. It is not an across-the-board quality program. It is about tools, it is about methodologies, and for us, it is about sharpshooting not shotgunning to figure out where the biggest areas of opportunity are. Because, we believe this market will stay competitive over the next decade.

Just a quick follow-up on Six Sigma in general and your approach to it. Would you expect that Six Sigma will lead to a general review of your overall product and services portfolio? Would you consider streamlining some of your offerings to focus on those that are both (ph) value-added?

The answer is yes. We began a process actually even before Six Sigma this past year that we called Fresh Look. We believe, again, as the business gets more competitive we need to do fewer things better. So we began that analysis, even before Six Sigma. For us, that means a tighter focus on countries, a tighter focus on portfolio. Only the ones that we believe we can be world class in are the ones that will remain at the end of this final analysis. The Six Sigma tools will help us. Remember, this isn't for us a generic quality program. It is a sharpshooting program to get to the vital few and you will see some action from us downstream as a result of that work.

Ashwin Shirvalkar. Smith Barney.

Thanks for taking my question. I was hoping you could go through your existing pipeline and describe it for us in terms of sort of an aging nemesis (ph). When can we expect to see new major contracts? What is the competitive program profile? Who are you competing against and has that change? Are you seeing maybe more Indian competition? Also, another aspect of signing new business is signing business from existing clients. So what is the progress there?

Thank you, Ashwin, and let me deal with each of those questions separately. The first is around the existing pipeline and I know that you have been tracking our $100 million pipeline for some time. There is actually only one deal that has fallen out of that out of the historical pipeline and that is a choice that we made to walk away from a very large engagement in the airline industry, just based on the financial difficulties of the industry and the risk profile of that engagement. So there is only one we have chosen to no bid for obvious reasons.

That pipeline has actually increased and we track it at multiple tiers, 30 million plus 50 and 100 million plus and all three of those tiers have actually increased. You will actually see some major new outsourcing wins we can't announce today. Probably in the next few weeks, but the first quarter isn't where we expect to see our biggest order growth. We have a very aggressive program for quite a number of large engagements in the second quarter. It is a fairly big spike for us. So we are pretty excited about 2Q. You'll see some of it come home in Q1. I think you'll see a fair number of additional opportunities come home in Q2.

In terms of the competitive profile, it is an interesting one. What we have found over the last 6 to 12 months is -- especially in the BPL space -- but across the entire outsourcing managed services space, a much wider range of competitors. In fact, you may have seen a recent TPI survey that said the largest clients are losing share because of the larger number of players in the competition. We believe that has driven down margins. It has made it more competitive. I think some of them will regret some of the deals they have won, based on pricing.

But it's essentially made it a more competitive market with a larger number of players competing. We have not seen a lot of Indian players in the spaces we compete. Now, remember, we are not in horizontal BPO and with the exception of the application areas we have targeted, we are not a major player in application outsourcing to India, which is the areas that you have seen most of the Indian suppliers become extremely successful in.

Your last -- so the competitive profile has become broader. It has become tougher. It is moved away from the largest companies and more of the smaller companies are winning and often on price.

In terms of our existing clients, that is a key focus for us. The example we used in the federal government is one of multiple examples that we piloted this program to put dedicated teams of sales and delivery resources across all of our business units toward large clients. We have had a very good success on those and that is the reason we are rolling out this top 50 program. We are compensating these teams on team-oriented comps. They will go to wherever the client's opportunity is as opposed to being so focused on being successful just in their own portfolio segment. And we have big expectations around our top 50 program.

Many of these clients have been with us in the 20- to 25-year timeframe. We often have great long-term relationships and it generally makes it easier to expand in those accounts.

The last part of this top 50 program is, as you might imagine the longer these clients have been with us there's a higher probability that they have ClearPath. The ClearPath monitors Asian program, we think, is a big deal. Because we believe we can dramatically slow down the decline in that business and here is why. We have trained all of the people in the systems integration side of our house around this methodology called the 3D-VE methodology.

What does that mean? That means they're all trained in the rational RUP (ph) method methodology. They all use .net and they all use J2EE. Because of the way we have reengineered ClearPath around application modernization, we can now take that team of thousands and thousands of application development people and build extensions and add-on applications to the legacy applications that make them Web enabled and much more exciting on the other side of the system. The other side is Intel running Linux or running a Microsoft datacenter.

So what happens is, in those large accounts, we believe we can dramatically slow down and potentially even increase the use of ClearPath across our largest clients. That is very important to us because you understand the profitability profile of that subsegment of our business. So I hope I addressed all three of your areas of questions.

James Kissane. Bear Stearns.

Joe, can you provide us a little more color on the hardware orders? Is the weakness broad based, meaning crossed existing customers who normally would be upgrading as well as potential new customers?

Yes. First let me start with the fourth-quarter miss. And Janet explained it I think pretty well, but if you remember the issue of revenue recognition in the fourth quarter, if we hadn't decided the way it did, you would have seen a different profile. Now we still fell short of our technology business in the fourth quarter; but that was a very, very large engagement. Because of the way that we have decided to recognize that revenue that is over five years instead of one large engagement in the fourth quarter. So it throws the technology business slightly out of kilt in terms of the calendarization of it.

In terms of the ES7000 business. That is still -- a very large portion of that is new business. That is, about 30 percent of it still remains new business. The other positive thing about the ES7000 is, we are getting more multi unit deals in that space and selling more of it into our existing clients.

Now if 30 percent is new, as you might imagine, the rest is into our existing clients and we have done a fair job there. We think an awful lot of its growth going forward will be because of we believe the tipping point in the Linux in the enterprise marketplace. Up to now it has been, when people bought Linux, they were essentially buying kind of raw technology and operating system. They build most of their own. You would often find it in research institutions, higher education, the areas that are normally early adopters.

That is finally becoming a solutions business that is finally going mainstream. Government is becoming very attracted to it. Telecommunications which already had a bias for UNIX is very attracted to that space and so we think you are going to see real growth in the enterprise segment Most of Linux has been the low end up till now and we believe you'll see the high-end start to expand. Is that where you were? Where you were going?

Yes, but also, I mean the revenue recognition probably was related to an order from a previous quarter. Where the orders in the fourth quarter were pretty weak as well.

Jim, this is Janet. No. That was not related to an order to previous quarter. As I said in my comments that was a deal that was signed in December. So this is not an accounting revenue recognition issue per se. It is just saved upon the final terms and conditions that were negotiated with the customer. We had hoped to be able to structure that in a way that that would come through the fourth quarter, but the final terms and conditions that were negotiated meant that accounting had to come in on a month-to-month basis.

Okay and thanks. Janet, if you exclude problem contracts from a services business, where are the services operating margins? Have you seen improvement there?

Jim, are you asking if we back out the problem projects?

That's right. Have you seen improvement towards your target if you exclude those contracts?

If -- when we said problem projects I think if you are referring to the BPOs that we talked about, the large transformational outsourcing. Clearly, that has had a significant impact on it year-over-year. We continue to see improvement in the systems integration margins continuing that progress. Actually within the rest of the outsourcing business, we are seeing some improvement in their margins; and in the infrastructure services area, we continue to see improvement. Expect that to continue as we go forward and we did hold the core maintenance flat and that and as well in the margins area for that.

Jim, I just want to reiterate. There is no change in our revenue recognition accounting policy. This is not a change in anything related to our underlying accounting. This is just this deal that we talked about in the quarter is just a function of the final negotiated structure of the deal that was done in December.

Thanks, Janet.

Cindy Shaw. Moores & Cabot.

I wanted to dig in on some of the things you've been asked about already. First, on the fourth quarter surprise in terms of demand weakness. Was that entirely the structuring on the revenue recognition? It sounded from what I heard on the call like there was just, overall, a bit less demand than you anticipated?

Cindy, we said that there were two things that we saw in the fourth quarter that affected the results. First is this large transaction that came in in December, but second, we did see some deals that we had anticipated closing in the quarter that we were not able to close. Based upon each and every one of them has a different story from a customer standpoint but it really reflects a lot of the continued controls over IT spending and capital investment. And we see that weakness there continuing into the first quarter when we look at the pipeline, particularly at the high-end servers.

So I just want to clarify. It was two items that affected technology business. One is how the final structure, the large contracts came in in December; and, second, was contracts that we had anticipated to close, that did not come through and that softening continued. We see that continuing into the first quarter.

So if I can follow up on that? The sort of continued costs on spending, especially at the high-end, your guidance for 2005. Are you assuming that that caution goes away and people open up their wallets a little better? Or are you assuming that you are going to get some share gains, basically from all the initiatives you have got going on?

Well, the first thing is, normally, you would expect some of those fourth quarter deals that we just described early in the first quarter and, frankly, we have not seen that and, actually, in our larger deals we actually tracked them account by account, deal by deal. We have seen some of those actually move to the second half. So I think you'll find that our technology business is second half loaded. We still believe on a full-year basis that we will have a credible technology year for the full year. Except it slipped out of the first quarter and you'll see the biggest gains in the third and fourth quarter. Cindy, I missed the second part of your question if you could repeat it?

Basically it is sounding like -- how much of the shortfall vs. your expectation do you think -- for calendar '05 is this -- are you looking for the initiatives you've got in terms of sales and a lot of the product initiatives to help push that pick up back in the second fiscal, and second half of the year?

Yes. The answer is absolutely yes. I think you'll see it on both sides of the business. You'll see a real pickup in the second half of the year on the technology side of the business. I think you'll start to see the orders growth in the second quarter as an early indicator for services. We are pursuing quite a number of 100 plus deals, 50 plus deals and 30 plus deals. A very exciting opportunity backlog that we are looking at for Q2, Q3, and a number of areas of our business and I think you'll see some early indications in Q1 but most of them in Q2.

Then, if I could dig in on the services side, the outsourcing contract sounded like you've done a lot of work on certain contracts. My question would be, have you gone through your contract portfolio in the BTO area to see if there might be a few other areas where that underestimation of how time-consuming transformation can be, are there any more surprises that we might hear about over the coming year?

Well, as you know, there is no way you can predict all surprises. But we have taken the initiative to go back and evaluate in a very deep dive every one of the BPOs. We know it is our area of greatest risk. Unfortunately, because we've become very conservative in pricing as a result of that, those lessons learned, and re-engineering where we did have root cost (ph) problem, it has become more conservative in our pricing. But I would like to believe that, clearly, the worst is behind us. There will be no major initiatives that we are already working.

Okay you've gone through the portfolio and taken a look?

Yes. We've gone -- the deep dive actually is a senior management team to take a deep dive in every single one of those.

Thank you.

Listen we have essentially run out of time. So the challenging 2004 has been a major disappointment for all of us; but I will tell you the entire senior team here is very optimistic after we get through our first quarter weaknesses for the balance of the year. And we want to thank you for spending the time with us today.

Thank you, and thank you, callers. That does conclude today's conference. You may disconnect your lines at this time and have a wonderful day.