Unisys Corp (UIS) 2005 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Unisys first-quarter 2005 results conference 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 hand the floor over to Jack McHale, Vice President of Investor Relations.

Thank you, operator.

Hello, everyone, and thank you for joining us this morning.

About an hour ago we released our first-quarter 2005 financial results and with us this morning to discuss our results are our CEO, Joe McGrath, and our CFO, Janet Haugen.

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 this 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 that providing this non-GAAP information is meaningful to fully understand our operating performance, because while pension accounting is nonoperational in nature, it does impact our reported results.

On the Unisys investor website, we will provide 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 the presentation slides we will be using this morning to guide the discussion.

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 filed with the SEC.

Now let me turn the call over to Joe.

Thanks, Jack.

Hello, everyone, and welcome to today's call.

To begin our discussion this morning, please turn to slide 1 for an overview of our performance in the quarter.

At our last call in January, we indicated that we expected the first half of 2005 to be challenging, as we worked through a transitional period in the business.

In particular, we needed to work through operational issues in our transformational outsourcing business; a soft demand environment for our high-end enterprise servers; and significantly higher pension expense on a year-over-year basis.

We also experienced in the first quarter some short-term disruption associated with organizational realignments and the launch of several new sales and marketing programs.

Due to these factors we reported a $0.13 per share GAAP loss in the quarter, and a loss of $0.04 per share excluding the impact of pension accounting.

Our revenue declined 7% in the quarter.

However, there were a number of positives in the quarter.

After a slow year for orders in 2004, we implemented aggressive sales and marketing programs to drive stronger order and revenue growth going forward.

We began to see the results of that effort in terms of our orders in the first quarter.

We saw Services orders had good growth in the quarter.

In particular, we saw substantial double-digit order gains for multiyear annuity-based outsourcing orders.

I was encouraged by this order growth, since I believe it indicates that our new sales and marketing initiatives are beginning to pay off.

Also in the quarter, we made progress in our initiatives to expand our use of offshore resources and implement our new Six Sigma lean program.

So, overall, while it was the challenging quarter for us, there were positive indicators that our strategy is working.

Today in my remarks I will provide an update on the initiatives we are pursuing as we work through this transitional period in the business to drive profitable growth going forward.

I will also highlight our major orders in the quarter.

First let me turn the call over to our Chief Financial Officer, Janet Haugen, for a review of the financial results in the quarter.

Janet?

Thank you, Joe, and hello, everyone.

This morning I will review our first-quarter results including our cash flow performance, and I will also update our financial outlook for 2005.

To begin, please turn to slide 2 for an overview of our orders in the quarter.

Overall our orders were flat in the quarter compared to a year ago.

However, as Joe mentioned, Services orders showed good growth versus a year ago, driven by substantial double-digit order gains for our outsourcing orders.

We saw particularly strong order gains for distributed infrastructure outsourcing orders in the quarter.

This is a positive sign, as infrastructure outsourcing is frequently an entree service into other Unisys offerings by new clients and often leads to further sales of other services and solutions with a client.

In fact a number of our large orders in the first quarter were with new clients such as New York City Transit.

Technology orders showed double-digit declines in the quarter.

For a summary of our income statement results for the first quarter of 2005, please turn to slide 3.

At the top line, we reported revenue of $1.37 billion, which was down 7% from a year ago.

Currency had a 2 percentage point positive impact on our revenue in the first quarter, reflecting the continued weakness of the dollar against international currencies.

At the bottom line, we reported a first-quarter 2005 U.S.

GAAP loss of $46 million or $0.13 per share.

Our first-quarter 2005 results include 47 million of pre-tax pension expense, or $0.09 per share.

This compares with pre-tax pension expense of 22 million or $0.04 per share in the year-ago quarter.

Excluding pension expense, we reported a net loss of $0.04 in the quarter.

Our first-quarter results also included a tax benefit of 7.8 million related to a favorable decision in foreign tax litigation.

Please turn to slide 4 for an overview of our first-quarter revenue by geography.

Our U.S. revenue declined 9% and represented 45% of our revenue in the quarter.

However, we saw within that U.S. revenue strong single-digit growth in our federal business.

Revenue from international regions declined 4% and accounted for 55% of our revenue in the quarter.

Moving to revenue by business segment, as you can see in slide 5, Services revenues declined 5% in the first quarter.

Services represented 81% of our total revenue in the quarter.

Turning to slide 6, within Services we saw revenue declines in all Services segments, with the largest decline in core maintenance.

Core maintenance declined 10% in the quarter versus a year ago.

We expect this segment to decline in the low double digits for the full year of 2005.

This is somewhat higher than what we have experienced in the past, and that is primarily due to some server and payment systems consolidation.

In the our project-based services, infrastructure services revenue declined 7% in the quarter as we placed more emphasis on building the multiyear annuity business, as shown in some of the nice orders in the quarter.

Consulting and systems integration revenue declined 2% in the quarter.

And for the rest of 2005, we expect our project-based services, infrastructure services, and consulting and systems integration to return to growth.

Finally, outsourcing revenue declined 5% in the quarter, reflecting the week orders in this area in 2004.

Here again we expect revenue to recover in the rest of 2005.

Turning to slide 7, Technology revenue declined 13% in the quarter and accounted for 19% of our total revenue for the Company in the quarter.

The decline in Technology revenue was driven by the 36% decline in specialized equipment.

We expect this business to recover in the second half of the year.

Enterprise server revenue showed slight declines in the quarter.

ClearPath sales were down in the mid single digits, while ES7000 sales showed high single-digit increases.

We look for ClearPath sales to remain soft in the second quarter, while ES7000 sales should be up in the double digits.

Moving on, expense trends and margins in the first quarter.

SG&A expenses excluding pension expense were down slightly, as we began to see some benefit from the cost reduction actions we announced late in 2004; and we expect to see more benefits from these actions in our SG&A in the second half of 2005.

Research and development expenditures, also excluding pension expense, were down about 10 million, primarily from the benefit of the 2004 cost reduction actions.

Slide 8 shows our operating margins excluding pension expense in the current and year-ago quarters.

First-quarter operating margin was 1.4% down in the quarter, down from 5.5% a year ago.

Slide 9 provides a comparison of our Services operating margin in the quarter.

Excluding pension expense, we had a -3.2 Services operating margin in the first quarter of 2005, compared to 4.1% in the year-ago quarter.

The year-over-year decline in Services margin primarily reflects the impact of a few challenging transformational outsourcing contracts that we are working our way through, the weakness in project-based assignment, and the drop-off in core maintenance.

Moving to slide 10, in our Technology business we achieved an 8.5% operating margin excluding pension expense in the first quarter of 2005.

This compared to a Technology operating margin of 9.5% excluding pension expense in the first quarter of 2004.

Now please turn to slide 11 for our cash flow and balance sheet details.

We generated $27 million of cash from operations in the first quarter of 2005.

This was down from 129 million of operational cash flow in the first quarter of 2004, and the decline was primarily due to lower income.

Capital expenditures for the first quarter of 2005 were $97 million, down from 123 million in the fourth quarter of 2004 and 113 million in the year-ago quarter.

About $76 million of our capital expenditures in the first quarter were for revenue-generating assets.

After deducting capital expenditures, we used 71 million of cash in the first quarter compared to 16 million of free cash flow in the year-ago quarter.

A few other notes on cash flow in the balance sheet.

Depreciation and amortization was 93 million in the first quarter of 2005.

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 million to $370 million range in 2004.

Also note, in the quarter in January we repaid $150 million of debt at maturity.

At the end of the first quarter, we had no borrowings against our revolving credit facility and ended the quarter with $442 million of cash on hand.

Now moving on, let me provide a quick update on the cost reduction actions we announced in the third quarter of 2004.

We remain on track with the plan for the 1,400 position reduction, which we expect to be essentially complete by the end of the second quarter of 2005.

As we have discussed previously, these actions will require about $65 million of cash in 2005.

But this cash usage will be offset from the proceeds of the U.S. and international tax refund, as well as the expected cost savings from taking these actions.

Turning to slide 12, I would now like to update our financial outlook going forward.

As expected, we look for the second quarter to be challenging as we work through this transitional period in our business.

We expect second-quarter 2004 earnings per share to be about breakeven, from $0.02 negative to $0.02 positive.

We anticipate revenue to be relatively flat versus a year ago.

Based on today's rates, currency should have around a 3 percentage point positive impact on our second-quarter 2005 revenue comparisons.

For the full year of 2005, while we continue to look for earnings per share between $0.50 and $0.60 excluding pension expense, but given the challenges of the first half, we are more likely to be at the low end of that range.

We look for our revenue for the full year of 2005 to increase in the low single digits from 2004 levels; and we continue to target free cash flow of more than $50 million for the full year of 2005.

Now I would like to turn the call back to Joe for more discussion on the business.

Thank you, Janet.

Now please turn to slide 13 for a strategic review of the business.

You'll recall from our call in January that we have three main strategic priorities to drive growth and enhance shareholder value in 2005.

First, we are implementing new sales and marketing activities aimed at driving order and revenue growth.

Second, we are executing cost reduction actions to drive down our cost base and enhance our internal efficiency.

Third, we are working on fixing the issues on our transformational BPO contracts and returning our outsourcing business to a growth profile.

Executing against these three priorities is critical to achieving our financial goals in 2005, which are to return the business to profitable growth.

I would like now to provide an update on these activities.

Moving to slide 14, our first priority is to implement sales and marketing programs to drive order and revenue growth.

As many of you know, we slowed the outsourcing new business development in 2004 as we worked to fix the issues on our outsourcing business.

As we entered 2005, with new processes and new senior personnel in place in our outsourcing business, we were determined to begin driving strong order growth again and to translate this order growth into revenue growth.

One of our primary sales and marketing initiatives in 2005 is to expand our share of our clients' IT spending.

In our Top 50 client program, for example, our focus is to substantially increase our revenue from our top 50 accounts across all Unisys businesses.

We call this our Blueprint Accounts program, because the program is a blueprint for how we want to serve our clients and because it leverages skills and methodologies from our 3D Visible Enterprise strategy.

This program makes use of dedicated sales teams, team incentives, and world-class client business planning to drive expanded success with our top clients and accounts.

Our top 50 clients today represent more than 2 billion of annual revenue, so it is critical that we understand their strategy and meet their needs with excellent service.

We are seeing good results in this program with selected clients, and we're focus on expanding this success with additional accounts as we go through the year.

For example, with two of our clients that we used as pilots, we were able to double the amount of annual revenue received from them by more fully understanding their strategies and initiatives.

In addition to overall programs such as Blueprint Accounts, we are also pursuing targeted sales and marketing programs within our Services and Technology businesses.

In Services we continue to drive revenue growth through aggressive marketing of our 3D Visible Enterprise strategy and solutions.

We continue to see momentum building for 3D-VE.

So far we've won nearly 75 engagements incorporating 3D-VE with a total value of about $700 million.

In the first quarter we won more than 10 new engagements that involve 3D-VE.

We also continued to use workshops as a way to build interest in 3D-VE among clients.

To date we have conducted more than 50 3D-VE workshops, and we have another 65 in the planning stages.

We also continue to leverage 3D-VE as the basis for innovative new services.

Last fall, for example, we launched the Unisys Global Visible Commerce program, a full portfolio of supply chain security programs based on 3D-VE.

More recently we launched a benchmarking service for customer relationship management that is based on 3D-VE.

Both programs have been well received in the market and are viewed as breakthrough initiatives that are winning us new clients.

We also continue to target growth opportunities in security, both in the commercial arena and in our U.S. federal business.

We see opportunities in making use of advanced technologies such as RFID, biometrics, and smart cards for use in security-related projects and programs.

In our Technology business we are implementing programs to drive revenue growth in our enterprise server programs, primarily with the ES7000.

We saw continued good growth in the ES7000 sales in the first quarter.

This was driven by customer acceptance of our 32-bit and 64-bit systems using Microsoft operating system software.

New sales programs for the ES7000 include a greater emphasis on selling the ES7000 as part of a bundled solution in areas such as database management, infrastructure management, and server consolidation.

For instance, we have recently launched a new bundled solution for the ES7000 in the disaster recovery market.

We also plan to introduce a pay-for-use capability for the ES7000.

We continue to target our ES7000 program for the high-end Linux market.

We have certified SUSE 9 and Red Hat 4 systems on the ES7000.

We expect sales of Linux-based ES7000s to begin contributing substantially to ES7000 sales by the end of 2005 and into 2006.

In our ClearPath program, while the first half will be challenging, with single-digit declines, we are looking for a much stronger second half of 2005 as compared to the first half of the year, as we drive our modernization program throughout the ClearPath customer base.

We continue to expand our metering or pay-for-use technology on the ClearPath platform.

Clients have responded well to this new feature, and we will be introducing additional models in 2005 that take advantage of this technology.

Our application modernization program is also key to our 2005 plans for ClearPath.

This program utilizes 3D-VE and leading-edge software to modernize a client's applications so they can be run alongside and concurrently with standards-based applications.

We believe that offering clients this feature will encourage them to expand the number of applications they use on the ClearPath platform.

One more note on sales and marketing.

On a management level, we took a major stride forward in the first quarter by bringing on Peter Blackmore as Executive Vice President of sales and marketing.

As many of you know, Peter was formerly with Hewlett-Packard where he was in charge of HP's enterprise server division and helped turn around that operation.

We are fortunate to have Peter on our team.

He has thrown himself right into the operations of the Company and is actively involved in programs to drive orders and revenue.

I believe he will be a significant contributor to our future success.

These are just some of the new sales and marketing programs that we are implementing.

While it is early yet in these programs, I believe we are beginning to see results in terms of new orders.

As you can see in slide 15, overall we closed more than 400 million of multiyear contract awards in the first quarter.

These included major wins with the New York City Transit, Resolution Life Group in the United Kingdom, a major U.S. financial services institution, and a major U.S. city public entity.

Also, early in April was signed a five-year 68 million agreement to provide IT infrastructure outsourcing services for a group of U.S. telecommunication providers.

We will host and deliver the datacenter operations and transition the current environment from a legacy to an open system platform.

So we are pleased the progress of our sales and marketing initiatives.

We had a good quarter in terms of Services orders, and the momentum has continued into the beginning of the second quarter.

We believe we're gaining traction in the marketplace and look forward to build on that progress going forward.

Turning to slide 16, our second priority in 2005 is to implement cost reduction actions that reduce our cost base and allow us to operate more efficiently.

In terms of cost reduction, we have both short-term and long-term activities underway within the Company.

Short-term we are implementing the cost reduction actions announced back in late 2004.

These cost actions, which involve reducing our headcount by 1,400 positions, are aimed at reducing our annualized cost base by about 70 million by the end of 2005.

We expect to be essentially complete with those reductions by the end of June.

We are not getting the full benefits of these cost reductions.

In the first half of 2005 there is some duplication of cost as we transition to new lower-cost work processes while at the same time funding the cost reductions.

We expect to begin seeing the benefit of these cost reductions in the second half of the year.

We continue to target getting our SG&A expenses, excluding pension expense, down below 17% of revenue for the full year of 2005.

Another area of cost reductions is our use of lower-cost offshore resources.

Here we are significantly expanding our use of offshore resources in Unisys global engagements.

As a global company, Unisys uses low-cost resources around the world in places like India, Eastern Europe, the Philippines, Malaysia, and Latin America.

Last month for instance we officially opened our new global service center in Bangalore, India.

This center can accommodate over 1,500 people.

We are using this center for application development, help desk, and outsourcing.

From this center we are supporting both existing clients and new engagements.

As we grow our global engagements, we continue to increase our staff.

We currently have about 1,200 India-based resources, and we expect to have some 2,000 in India by the end of 2005 working on Unisys client engagement.

We expect to grow our resources and India to some 4,500 by 2008, with more than half of those being direct Unisys employees.

Our business model in India is to make use of both Unisys and third-party partner resources.

Making use of our partners' resources in India gives us the flexibility to adjust quickly to demand levels.

We are also exploring other possible service centers in Eastern Europe and in China to provide offshore resources.

Offshore is making us more competitive in the marketplace both from a strategic and a cost perspective.

We are pursuing it aggressively.

In addition to the 2004 restructuring actions and expanded use of offshoring, we are also launching a much broader effort to enhance overall efficiency of the Company through our new Six Sigma lean program.

I mentioned this program in our last call in January and will continue to refer to it because of the importance of this program.

I believe it is critical that everything we do at Unisys be measurable in terms of its cost and its benefit to the customer.

That is the purpose of our Six Sigma lean program, to ensure that we're doing those things and only those things which contribute to customer value and shareholder value, and that we're doing them in a benchmarked, world-class way.

In the first quarter we identified and launched nine initial Six Sigma lean projects targeted to improve our sales and delivery excellence.

Each of these areas has dedicated project leaders, executive level sponsors, and subject matter experts, all of whom will be responsible for driving measurable results from the projects.

Later this year we will launch a number of other projects under the program and more will come later in the year.

We expect this program to significantly change the culture of Unisys and lead to a much more productive, cost-effective company that can be benchmarked competitively with the best of class in our industry.

Six Sigma lean is not just a cost reduction program.

It is really about productivity and growth.

However, we expect the program, in addition to the other initiatives underway, to contribute significantly to our cost competitiveness.

Our third key priority in 2005 is to return our outsourcing business to profitable growth.

Please turn to slide 17 for an update on our initiatives in our outsourcing business.

As you recall, we have a few transformational BPO outsourcing operations that are particularly impacting our results, and we are working proactively to fix the issue in this business.

We are in the process of renegotiating these contracts.

In the meantime, we have hired new senior management and have begun to streamline the business processes.

We are making some progress, but we expect these contracts will continue to be negative drag on our margins throughout 2005.

We also expect our outsourcing orders to improve in 2005.

In 2004 we had slowed down our outsourcing bidding work, as we began to correct the problems in the operation.

But in 2005 we are being much more proactive in going after new outsourcing opportunities.

We began to show results from that effort in our orders in the first quarter.

We expect to continue this order momentum in the rest of the year and translate this order growth into revenue growth.

We have also made organizational changes in our outsourcing business aimed at driving business growth.

For instance, we recently combined the two organizations that manage our data-center outsourcing and distributed infrastructure outsourcing businesses.

Having them separate was inhibiting our ability to go to market as one Unisys and win bidding opportunities.

Since joining the two organizations, we have won a number of major proposals, such as New York City Transit contract.

While we have some challenges in our transformational outsourcing business right now, outsourcing -- particularly the transformational business process outsourcing -- remains the fastest-growing area of the Services market; and we continue to focus on outsourcing as a key generator of our own growth at Unisys.

Turning to slide 18, in summary, while the first quarter was challenging, we saw a number of positive signs in the business.

We saw good Services order growth, particularly in our strategic focus area of outsourcing.

We continue to make progress in reducing costs and expanding our use of offshore resources.

We launched our Six Sigma lean program.

We continue to make improvements in our outsourcing business.

Overall, we made progress in the quarter.

We look to continue this strategic progress in the second half and have set ourselves up for an improved second half of 2005.

Now I will turn the call back to Jack to open up for questions.

Thank you, Joe and Janet.

Operator, we would now like to open it up for the Q&A session.

(OPERATOR INSTRUCTIONS) Julie Santoriello of Morgan Stanley.

Joe, I guess I don't completely understand at this point really what the cause was for the shortfall in revenue in the first quarter, as well as in gross margin.

Well, the shortfall in revenue frankly reflected a shortfall in orders we had in the fourth quarter across our entire Services business.

Frankly every area of our Services business had an order decline year-over-year in the fourth quarter of '04.

We worked hard to make up that gap in the first quarter, but the biggest struggle that we had in the first quarter was across those services businesses.

Was there anything tied to the transformational outsourcing problem contracts that fell short of your expectations in the first quarter?

Yes.

The answer is absolutely yes.

It affected two businesses, frankly.

The business it affected the most was outsourcing.

Remember, outsourcing orders in the first quarter were down.

We are very excited that they are up substantially in the first quarter, but we really saw a decline in our outsourcing business there.

We also diverted some of our systems integration resources to help in the remediation of those businesses, and it had some impact on our system integration business.

On the Technology side, as you can see, we had a significant year-over-year decline.

The positive aspect of that is that was predominantly in our specialized equipment business, and the subset of that was primarily our chip business.

We expect to see an improvement in those businesses in the second half of the year, as well as all of the Services business I talked about.

Although we redeployed some of the systems integration resources, we think those had a big positive impact on order growth, and we'll accelerate that order momentum in Q2 and the second half of the year in our outsourcing businesses.

Thanks, and on that topic, can you share with us a bit more or give us an update on the pipeline and the timing of some of the large deals in the pipeline?

Yes.

I think we were very positive in terms of, again, the first quarter.

I think you'll continue to see we have about 3 billion of active pursuits in the outsourcing business overall.

I think you'll see a successful second quarter in order growth there, and again our key is turning order growth into revenue growth.

But you'll see in that business a continued acceleration over the course of the year.

If I could get one more question on margins, just in light of the negative operating margins that you are faced with this year, do you think that you'll need to get more aggressive on the cost-cutting side?

Are there parts of the business where you see growth prospects may be limited in the foreseeable future, where you could begin to step up some of the cost-cutting and bring those margins back to positive territory sooner?

The answer is yes.

In addition, and I think you heard the number that we expect to see at a full run rate by the end of the year in terms of the initial cost-cutting; but the whole purpose and the underpinning for this Six Sigma program is this is a race that has no finish line.

I believe that this cost reduction program is a continuous process.

You heard about the first initial programs that we put in sales and Services delivery, but we will continue to double and double again the number of Six Sigma black belts and putting them on high-profile projects around our company.

You'll see us continue to take costs out in every major area, not just to improve our margins but because of the increasing competitive nature of our business, which is impacted by, clearly, global sourcing as you know, as well as the impact of the open source movement.

So you are absolutely right.

You will see us continue to aggressively take cost out beyond the original 1,400 we talked about through process re-engineering.

Thanks, Joe.

Ashwin Shirvaikar of Smith Barney.

I guess the first question is on project-based services and in some of the other lines.

You expect a return to grow second quarter and beyond.

I just wanted to get a little bit deeper into what's the underpinning for your confidence that that growth will be there.

Thanks for your question, Ashwin.

We see very modest growth in project-based services in the second quarter, but we believe that you'll start to see that accelerate and momentum build there also in the second half of the year.

Again, remember, orders being our kind of early key indicator of this.

Part of it is, as you have heard earlier, we rolled some of our systems integration business development and delivery resources to remediate and help grow our outsourcing business.

Some of those we will roll off; and in some of those there will be increased embedded work, if you would, in a lot of the project-based work.

But in both cases -- embedded within our outsourcing business as it grows and rolling some of those resources back to their traditional responsibility -- we will continue to drive the project-based services.

On the Technology side, as well, do you expect improved performance in the second half?

What is the basis for that?

Let me start with the ClearPath program.

The ClearPath program -- although it may sound mundane or pedestrian, this idea of application modernization -- remember the ClearPath architecture shares a common family, if you would, with the ES7000.

So our entire Technology family is based on this common architecture.

Because of that, we can build these hybrid proprietary open systems; and because of the open side of ClearPath -- and many of those systems have upgraded to this hybrid system over the past 12 months or so -- there is this just very strong movement that we now have to modernize those applications.

The open side would use technologies like .net and J2EE to build new web-based services on the other side of our proprietary applications.

The reason we have able to maintain the base is many of our customers have very big investments in the proprietary side of their technology, and it would be a massive undertaking to rewrite that.

So instead of them rewriting it, we're going to drive an open system web-based other side of those applications.

We believe that will drive increased utilization of the proprietary side of the machine.

And we expect, we have big expectations for application modernization -- although it does not sound sexy, if you would -- for maintaining and growing the ClearPath base.

In terms of the ES7000 side, we have made investments and we continue to make investments on the Microsoft side and the Linux side.

We see the payoff for Linux occurring in the second half of this year.

Another question if I may.

What is the strategic rationale to keep the specialized technology line?

I do understand you have some sell through that the clients ask for.

But outside of that, do you really see continued strategic requirement to keep that line as a part of your ongoing business?

That is a great question.

There's, as you know, two primary pieces to that business.

Let me start with the one that you might be referring to, which is the chip testing business.

The chip testing business is a very cyclical business for us.

The reason it had such a big impact is we are very dependent on a few number of very large clients, based on the real special nature of this chip testing business.

It is a very lumpy business.

We got hurt in the first quarter, and that was the biggest chunk of this specialty equipment take down.

Now we expect, like any other cyclical business, for that to ramp up in the second half of the year.

But we are always looking at strategic alternatives for all of our businesses.

We are not prepared to say anything specific about that.

But the answer is, you're right.

It has a big impact on our business.

It is not strategic as some of the other elements that you are aware.

And over time we will examine all options.

The second one is payment systems, and that is the second largest part of specialty equipment.

As you know, the overall check processing volumes around the world are in a continuous gradual decline.

In our case, what we have seen is consolidation of some of the sites of some of our largest customers.

That has affected the payment system part of our business; and frankly that has a knock-on effect of some of our core maintenance business.

So as we consolidate the payment system hardware, it has an equal and mirrored impact on the overall core maintenance reduction that you also saw in the quarter.

Okay, thanks.

That's helpful.

Thank you.

Cindy Shaw of Moor's & Cabot.

Following up on your payment systems comment, Check 21 went into place in late October.

I know that take-up on Check 21 as we went into that was not what folks had anticipated.

Any signs now that it has happened, that there might be some take-up on that?

Cindy, that's a great question.

We have been waiting for it to pick up, too.

Most of our business that we have found in there has been consulting business for a lot of our existing clients.

There was two other side effects.

We thought a lot of these early consulting engagements would turn into much larger systems integration engagements.

In some cases that did occur.

But in other cases, it has not panned out as much as we would have liked.

The other secondary effect that we expected there is a greater movement to payment systems outsourcing.

Frankly that has been slower than we expected as well.

Now, we have seen some impacts in that business, in ATMs and other parts of it, but we have not seen a big uptake in our business as a result of Check 21.

Okay.

Then on Technology you've noted your looking for a strong second half.

Orders really not ticking up yet.

What is the lead time on that?

When should we be looking for orders to tick up, particularly given that third quarter is pretty back-end loaded usually?

I think you're going to see continued softness in that business in the second quarter, and you won't really see that start to ramp into the second half.

Orders are less of a key indicator for that business than they are for our services business because they have a much larger portion of what we call sell and bill.

We write the order and install the equipment in the same quarter.

So you would look less to orders as a key indicator.

But we will tell you from our own tracking and out-looking systems internally, we expect a big increase in the second half.

Okay, then finally you have talked in the past about in the BPO environment some competitors being really irrational in pricing.

Are you seeing any change to that?

Yes and no.

The business continues.

Everyone can read the same market sizing numbers from any of the Wall Street firms, as well as Gartner, Meta, and others, that it is the highest growth segment of the overall business.

So it continues to attract more and more competitors all the time.

We have seen a little less irrationality in pricing, although -- and I think it has become a little bit stabler because I think many of the people in the business, in the BPO business itself, have faced some of the troubles that we have as well.

So I think they will all go through a patela (ph) process that we recently went through, which is much more controls on the business, much higher levels of scrutiny in terms of their pricing, and I think you will see pricing stabilize and over time start to climb again.

Interesting.

One final housekeeping question, we haven't anything about stock option expensing this quarter.

Any change to what you told us in January?

No, there is no change.

There is no change to what we told you in January.

However we are following the reason developments from the SEC as to whether that does postpone into 2006.

Great; thanks very much.

Christine Pezino of JP Morgan.

I was hoping you could discuss some of the trends you're seeing in the vertical markets.

You mentioned that you saw single-digit growth in your federal business.

What are your expectations there for the federal market?

Have you seen any delays or impact from some of the turnover that has happened at the Department of Homeland Security?

As you know, our public sector business overall has been our highest growth industry for quite some time, and we see that continuing.

You'll continue to see growth in our federal business.

I think we have seen more cost constraints in the state and local business around the United States, but federal continues to be a strong business for us.

In the area of Homeland Security, there has been no real impact on our business around the transitions that they have been going through.

We believe we have very strong and deep-seated relationships that will carry us through some of the changes in the agency leadership.

Okay.

In terms of your offshore strategy, as you move some of the existing work offshore, do you have targets for how much work you want to be doing offshore and what kind of impact that might have on revenue growth in the future?

The revenue growth is a great question, because most people underestimate the implication of that.

But we would like to, as a long-term target, have 20% of our total employee population in low-cost countries.

That is one of the reasons it was important for us.

You have seen most of the growth for others and ourselves in India.

We believe that China and Central and Eastern Europe will be equally important going forward.

China especially in servicing not just the Chinese-speaking countries themselves but Japan; and so we are investigating there.

As well as Central Eastern Europe because of the European Union and the preference -- with the exception of countries like the UK and English-speaking countries -- they would rather send their work to a lower-cost European Union country.

We have had a long history in Central Eastern Europe.

We are examining whether or not we should ramp up there and China, as well as what you have heard from us in India.

Okay, and then just on the competitive landscape in some of these contracts you won, are there players that you are seeing more often?

What kind of competition are you seeing from the pure-play offshore Indian firms?

Let me start with the second part of your question first, then come back to the first.

The Indian offshore firms have been very successful in doing maintenance and sustaining of existing applications, and have moved from the old legacy applications to ERP.

We don't see them that often, because we were never big player in traditional ERP.

So we don't face off against the Indian players as many of the largest players in ERP implementation did.

In terms of our traditional competition, this market continues to get more competitive all the time.

Because of intermediaries in the largest deals, especially in outsourcing, companies like TPI and others, all of the major players often get invited to all of the major engagements.

You find more and more of a very large field beginning in these competitive engagements and going through multiple rounds of competition.

So as you might imagine, we are always facing IBM, Accenture, and EDS.

We believe that our industry focus and our domain understanding is our critical differentiator in that.

When we win, as you saw some of the breakthrough wins like Resolution Life, it was our deep domain expertise and insurance back office in that particular case that proved to be the difference.

Okay, great.

Thanks.

Peter Labe of Nutmeg Securities.

Over time you have given out a lot of targets on operating margins and gross margins, I think, which were in the high 20s.

Have those been recalibrated?

Because certainly the industry looks like the next few years are going to be different than maybe when some of those targets were made out.

Or maybe you would just simply update us on what you think the targets should be.

Peter, it's a great question.

First let me deal with it in the broader way you posed it, and then let me come back specifically to us.

First let me level set.

It is very hard to compare gross margins between companies because of we all bucket things in different categories.

So gross margin is often not the absolutely right key indicator to face off between major competitors.

We think operating margin is.

With that said, you're absolutely right.

A number of years ago and especially in the second half of the '90s, when this industry was growing at a breakneck pace, there was very different expectation of overall margins.

Global sourcing has had a very big impact on that, as well as the number of tough competitors that have gotten into this business.

So to some degree global sourcing will forever -- not just India -- global sourcing will forever change the economics of the service business.

We all have to face that.

If you remember Julie's earlier question about cost reduction, it puts us all in a very different world about continuous cost reduction.

That said, you're right.

I think all of us have to recalibrate the overall margin expectations on a subsegment by subsegment basis of the overall industry.

Now, do we still believe that we can get back to some of the margins that we had set, like a 10% overall operating margin, a few years ago?

The answer is yes.

The problem that we have, however, in the short term is -- and we believe that we were marching down a track to eventually get us there -- is we have been, as many people on the call know, have been hit by a sufficient erosion in some of these big business process outsourcing contracts.

And because of the length of those contracts and the requirement of what it takes to work your way through it, you'll see us on a much slower growth path to get to those original targets.

(inaudible)

Ed Caso of Wachovia Securities.

This is Eric Wirr (ph) in for (technical difficulty) for Ed.

Joe, you talked about closing 400 million plus of multiyear contracts in the first quarter.

I was wondering what that number was a year ago.

That is a great question.

I will have to get someone to look it up for you.

But would you say it is trending up?

Oh, yes.

I will get somebody to get you the specifics.

Janet?

The orders a year ago in the multiyear annuity were -- particularly when you consider the first one, the one that we closed early in the second quarter -- the orders were, particularly in the outsourcing business, up probably close to 70 to $100 million more than we would've seen last year.

So we are particularly encouraged by that.

That is a 30 percentage increase year-over-year.

Given what we came out of at the end of fourth quarter and the challenges in the infrastructure outsourcing annuity business, that's what gives us some of the elements of the confidence as we move into the second half of the year, because those orders are stronger.

They're coming from new customers.

They are coming from, as we said, the entree area for us to build and expand relationships with.

We start this second quarter with a win early in the quarter in that same area.

Great.

I guess in past quarters you talked about the number of $100 million deals you had in your pipeline.

I was wondering where that number stood today.

We have generally referenced that we always have a minimum of 10; and we have a minimum of 10 $100 million again.

Frankly it has always been slightly larger than that, but to be conservative there's 10 that we have a fair amount of confidence that we are pursuing.

I actually think that over time, based on an infusion of talent that we have talked about earlier, that we will improve our win rate in a lot of those very large multiyear contracts.

In addition you have also heard us say in previous calls that we put much greater senior executive attention all through the proposal process to ensure these higher win rates, and I think that is going to impact our win rate is well.

But let me add something that Janet said a second ago.

The reason these -- despite the bump in the road we hit in these transformational BPOs -- the reason this business is so attractive and so strategic to us is, one, its growth rate; two, its size over time.

But the annuity business overall as you well know has 90% backlog often going into a year or into a quarter.

So when you start to ramp your order numbers, as you just heard, knowing that it is a much more stable and less volatile business than some of the other businesses we have talked to earlier, you can see why we find that business so attractive.

If I could just get one last question in there.

I guess the last couple of quarters (inaudible) industry about (indiscernible) contract value and deal durations coming down a bit.

I was wondering how these metrics are trending for Unisys.

Yes, and I can't be specific because I don't have it in front of me.

But yes, we have seen slightly smaller deal sizes.

About the same duration.

But the overall population of deals we are chasing have continued to decline, not substantially, but decline in terms of total value.

Probably more contracts with option years added on.

So it would be duration that we may have looked at before; the size in aggregate, including the options, perhaps around the same size; but you see more customers putting those clauses and preventions to have assessments in the contracts to allow them to decide to continue with options.

But you know, I think this also could be explainable that many of these are split into pieces.

I think a few years ago you saw more megacontracts; and you would also see more dissatisfaction between the client and these megacontracts.

I think clients are being much more careful as they break these up into smaller, more manageable pieces, and so that they can manage their partner/vendor population more carefully.

That is actually good for us, because in certain areas of the business -- like infrastructure services, where you have heard Janet say earlier it's one of the fastest-growing parts -- we believe we're really privileged there.

Sometimes if it is an all IBM data center and we're disadvantaged, breaking it into the smaller pieces plays into our strengths.

Okay, thanks.

Listen, I want to thank everyone for the call.

Thank you very much.

For those of you that need to call Janet or myself later, please work with Jack.

Thank you again.

Goodbye.

Thank you.

This does conclude today's teleconference.

You may now disconnect your lines, and have a wonderful day.