Unisys Corp (UIS) 2005 Q4 法說會逐字稿

Good day, everyone and welcome to this fourth quarter and full year 2005 results conference call for Unisys Corporation.

Today's conference is being recorded.

At this time for opening remarks and introductions I would like the turn this call over to Mr. Jack McHale, Vice President of Investor Relations at Unisys Corporation.

Mr. McHale, please go ahead.

Well, thank you, operator.

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

Earlier this morning Unisys released its fourth quarter and full year 2005 financial results and with us this morning to discuss those results are Unisys CEO, Joe McGrath; and our Chief Financial off -- Officer, Janet Haugen.

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

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

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

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

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

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

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

Finally, I'd 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 earnings release and the -- and in the Company's periodic reports as filed with the SEC.

Copies of these SEC reports are av -- are available from the SEC and from Unisys investor website.

Now, let me turn the call over to Joe.

Thanks, Jack.

Hello, everyone and welcome to today's call.

To begin our discussion please turn to slide 1 for an overview of the quarter.

The employees of Unisys turned in a solid performance in the fourth quarter of 2005.

We achieved the high-end of our pre-tax income target and delivered strong free cash flow in the quarter.

There are many positives in the quarter but in my mind there were three highlights.

First, we began to see improved traction in sales as we benefit from new sales and marketing programs and leadership that we're put putting in place.

Second, we saw strong growth in orders in the quarter, outsourcing orders were particularly strong, more than doubling from year ago levels.

Our outsourcing revenue also continued to show mid-single digit growth in the quarter.

This is critical as we continue to build our annuity revenue.

Third, we saw strong results in technology in the quarter as technology revenue was up double digits.

ClearPath revenue was up mid-single digits and ES7000 sales showed 20% plus growth.

Orders also showed good growth for technology.

Other highlights included signing the bridge contract with the U.S. transportation security administration, and recently finalizing the new restructured agreement on or iPSL check processing processing joint venture.

Equally important we made good progress against the plan I laid out in October to reposition Unisys in the marketplace and enhance our profitability going forward.

This morning I would like to give you an update on the repositioning plan and key elements.

But first, please turn to slide 2 for highlights of our financial results in the fourth quarter.

At the top line we grew revenue 3% which was actually 5% on a constant currency basis.

This was driven by 11% revenue growth in our technology business as we successfully closed a number of large technology transactions that we had in our pipeline.

In our services business we saw solid growth in outsourcing and in infrastructure services.

We reported fourth quarter 2005 pre-tax income of $72 million excluding pension expense.

This was at the high-end of our guidance of pre-tax income excluding pension expense of between 50 and 75 million in the quarter.

A year ago we reported a pre-tax loss, excluding pension expense, of 67 million.

The year ago results included an asset impairment charge.

I just want to remind everyone that there's been a big change in our tax rates which impacted earnings per share in the quarter.

Our Chief Financial Officer Janet Haugen will provide detailed information on the tax rate and other financial details in her remarks.

Overall, I was very encouraged by our performance in the quarter and believe it represents a positive step toward regaining our financial momentum.

I was particularly encouraged by our strong orders in the quarter as we begin to see initial results from our new sales and marketing programs.

We closed a number of significant orders in the quarter.

Please turn to slide 3 for a sampling of our key wins.

During the quarter Unisys was awarded a bridge contract from the transportation security administration to continue providing managed services to TSA and the Department of Homeland Security headquarters.

For the past three plus years, Unisys has been working closely with TSA and DHS to build and manage a secure IT infrastructure for ensuring the security of passengers across the United States.

Under the new contract Unisys will continue to provide desktop and network management and support, help desk services, IT security services, application management and other services.

The contract is for a one-year base period and two additional one-year options.

The value of the one-year base period is estimated to be 308 million with a total ceiling value of the entire three-year period estimated at $750 million.

We are pleased to be able to continue providing these critical services to TSA, and we look forward to continuing the partnership we've developed over the last few years.

Also during the quarter Unisys was selected as part of a consortium led by Cap Gemini and also including British Telecom to modernize the information systems and security network used by the Metropolitan Police Service in London.

The total contract as awarded to Cap Gemini was about 350 million pounds, or about $620 million over the seven-year term.

Unisys is a major subcontractor to Cap Gemini and we will provide application management, desktop management and support and some data center services.

This is significant new business with this long-term customer and we're pleased to be part of this winning team.

The work will be transitioned to the winning team over the next several months with the work to begin around June of 2006.

We also continue to win contract extensions from existing clients.

During the quarter Countrywide Financial, a leading provider of financial services, awarded us a significant three-year contract extension to provide outsourced management and support services to more than 80,000 devices throughout the United States.

The extension continues our three-year relationship with this U.S. financial services leader.

Another existing client, the Bavarian Ministry of Justice, also extended its infrastructure managed services contract with Unisys.

During the quarter the ministry signed a significant contract extension for Unisys to continue providing a range of managed services to help the ministry modernize and manage its IT infrastructure.

Unisys has been providing services to the Ministry of Justice since 2002.

We also received a significant seven-year contract extension from Land Transport in New Zealand for IT outsourcing services.

In terms of major technology contracts, we received a significant fourth quarter contract from a major financial institution in Europe.

This customer awarded us a more than 70 million contract for the new ClearPath software, hardware and multi-year support services.

This new system will run the clients retail and mortgage operations.

In addition to the size and name recognition of these key clients, these wins were significant because they come into our key business areas including outsourcing, security and ClearPath.

These wins demonstrate the competitiveness of our offerings in these areas but they also show the enhanced sales in marketing programs are beginning to deliver results.

We end the year with good order momentum and we want to keep it going in 2006.

Turning to slide 4, I'd like now to provide an update on the plan we laid out in October to reposition the business for accelerated growth going forward.

As you may recall from our discussion in October, this plan is intended to significantly enhance our margins and profitability, address our performance issues and drive enhanced success in the marketplace.

Broadly speaking, there are four key elements to this plan.

First, we have decided to focus on investments and resources going forward on specific high growth markets.

As part of this effort we are pooling our delivery resources around these high growth areas to optimize utilization of our services personnel and improve services growth and margins.

Second, we plan to exit or divest certain non-core assets that are outside of these focus areas.

Third, to support and reflect our more focused business model we plan to right size our cost structure and reduce our worldwide how -- head count by about 10% over the next year or so.

Fourth, to drive order and revenue growth through our more focused business model we're making significant changes to our sales and marketing leadership and programs.

As we discuss in October, this repositioning plan is far reaching and will take some time to fully execute.

However, we did make good progress in implementing parts of this plan in the fourth quarter and I'd now like to go through each of the -- these four elements of the plan.

Starting with our overall business refocusing effort please advance to slide 5 for an update.

As discussed back in October we are tightly focusing our investments and resources on large mainstream market areas where we have strong capabilities and that are expected to grow at above average rates over the coming years.

The areas that we're targeting for growth are outsourcing, enterprise security, Microsoft Solutions and open source and Linux solutions and support.

In addition, in our technology business we will focus on providing flexible realtime infrastructure solutions through our Clear -- ClearPath and ES7000 servers and the associated middleware software.

These services and solutions will be delivered through our vertical industry focus to the market.

To capitalize on these growth opportunities we are reorganizing our global services delivery force worldwide.

The goal is to create concentrated pools of people who are highly trained and skilled in delivering services in these growth areas.

These people will then be deployed on projects as we win opportunities in these areas.

During the fourth quarter we went through the process of identifying our delivery employees according to their skills and mapping them to the new targeted growth areas.

The new refocused delivery organization was launched in January.

In recent weeks leader of the new -- leaders of the new delivery pools have been named and employees and managers have been or are now being notified of their new organizational assignments.

Intensive training in the new focused areas is being developed and implementation is beginning this quarter.

So overall this pool of delivery resources is a very significant effort to enable us to be more effective in delivering services in high growth areas.

And we believe this effort will allow us to significantly increase the capabilities and utilization of our delivery force globally.

Please turn the slide 6 to discuss where we stand in our cost reduction programs.

We are implementing a major reengineering of our business in our global operations to drive operational efficiency while also improving our ability to meet changing client needs in the market.

By doing this, we will be able to complete -- compete more effectively while also reducing our head count by about 10%, or about 3,600 positions, as we previously announced.

This should allows us to take approximately 250 million out of our cost base on a run rate basis by the end of 2007.

In other words, we are reducing costs by changing the way we do things rather than simply by cutting head count.

This reengineering touches nearly every aspect of our global operations and we did a great deal of work in the fourth quarter to reengineer processes as we begin to prepare for head count reductions.

In services, for example, the pooling in service delivery personnel that I just described will enable us to reduce the costs of service, improve utilization of our people and give our people the necessary skills to be able to meet the growing need in the service areas of the market.

In technology, we are reengineering the way we approach hardware design and development in order to reduce research and development expenses while also increasing innovation for our clients.

In the fourth quarter we announced a memorandum of understanding with NEC of Japan under which we will partner with NEC to collaborate on hardware design and share R&D costs on future platforms.

This will allow us to focus our investments on operating and system management software and reduce hardware R&D and manufacturing costs while opening our client base to innovations from a major global technology leader.

This alliance has been well received among our clients, and we hope to reach a final definitive agreement in the coming weeks.

In both services and technology, we are expanding the use of offshore resources in India, China and eastern Europe to lower our cost of delivery and improve our effectiveness.

By doing this kind of process reengineering we will be able to reduce our head count but first we must reengineer the processes.

The timing of these reductions will largely depend on the timing of divestitures as we plan to use the funds from the divestiture program to fund the head count reduction actions.

So let me give you update on the divestiture program.

For this, please turn to slide 7.

In the fourth quarter we assigned a dedicated team of individuals and an overall project manager to the task of driving the di -- divestiture program.

We have identified the non-core assets for divestitures and we have talked to potential interested buyers for a number of these assets.

We may be able to announce agreements on certain transactions in the first half of 2006.

So overall, our cost reduction and divestiture programs are advancing and we expect to benefit from them as the year progresses.

Moving on, please turn to slide 8 for an update on our sales and marketing activities. 2005 was a rebuilding year for our sales and marketing programs worldwide.

We made significant changes in our sales management and our sales and marketing activities to drive stronger profitable revenue and order growth.

While we have much more work to do, we have made very good progress in the sales and marketing area.

During the quarter we continued to upgrade our sales leadership team adding three new global industry sales leaders.

This is in addition to the leadership changes we made in the third quarter in North America, Europe and worldwide technology.

In the sales area we made important changes to our sales coverage and compensation programs to drive growth in our targeted business areas.

As we discussed last quarter we are focusing our sales effort our top 500 client accounts worldwide which account for about 85% of our revenue.

To drive growth among this set of clients we have assigned dedicated sales teams and resources to our top 500 client accounts worldwide.

We believe that focusing on our top accounts will enable us to win a bigger share of wallet among these large accounts and accelerate our growth.

This top 500 account plan builds on our blueprint account program which I discussed earlier in 2005.

The blueprint account program was focused on increasing our sales to our top 50 accounts worldwide.

As a result of the blueprint accounts program we have seen increased success with some of our larger accounts.

For example, the Metropolitan Police Service in London has been a longstanding client for our ClearPath systems and for software.

We recently doubled the size of this account with the recent win that I discussed earlier.

We also have fine-tuned our geographic coverage.

In the fourth quarter, and in early January, we have concentrated our sales efforts on our top 10 countries worldwide that account for about 85% of our revenue.

These countries are focused on 2000 -- in 2006 is on selling the full portfolio of Unisys services and technologies.

For about 30 smaller countries we have created a streamline overhead management structure.

In these countries we are focused on meeting specific needs of specific client accounts rather than attempting to sell our full portfolio.

To support this new coverage model we have put in place focused sales incentives beginning January 1, 2006.

These incentives are team centered, account centered and cross portfolio based.

That is, we have structured compensation that our sales force is motivated to work with other Unisys organizations to sell the full portfolio of Unisys solutions to specific named accounts.

We believe these sales programs will be a key factor in driving order and revenue growth in 2006.

In the marketing area, we're supporting the sales function through targeted marketing programs aimed at our top 500 accounts.

Also, during the fourth quarter we formally relaunched the Unisys brand based on the new focus areas that we are targeting in the market.

Our brand is built around enhancing our reputation as a provider of services and solutions for secure business operations.

We have launched this refreshed brand in North America and Europe and have inaugurated a series of activities in the first half of this year to continue to ensure that our brand message and capabilities are well understood by our customers.

We are also planning additional launch events in other geographic regions in 2006.

In the area of strategic alliances we continue to make progress in building strong partnerships with a select group of partners including Microsoft, Oracle, EMC, SAP, Dell and NEC.

We expect these expanded partnerships will enable us to accelerate our profitable revenue growth.

So we've made many significant changes to our sales and marketing efforts and we're hopeful that the changes we made will drive improved results as we move through this year.

Before we discuss our financial goals, please turn to slide 9 for an update of the two -- on the two challenging business process outsourcing operations that have been impacting our results.

As mentioned in earlier calls, one of the challenging operations is our iPSL, check processing joint venture in the United Kingdom.

Earlier this week we announced that we had reached an agreement to restructure this operation.

The financial aspects of the new agreement are essentially the name as the MOU that we described last quarter.

Under the agreement, which went into effect on January 1st, Unisys will continue to process checks for our partner banks but at a higher tariff arrangement that better reflects the economics of the operation.

Based on the new tariff structure, Unisys expects to receive an additional approximately $150 million over the 2006 to 2010 time frame.

This, in addition to expected cost savings, will enable us to operate iPSL at or near break even in terms of profit.

The other challenging utility operation is taking longer to resolve.

We anticipate a reduction in our losses in this operation in 2006 and beyond and are working to renegotiate certain additional terms and conditions in 2006.

Moving on, as a result of the repositioning and business improvement activities that we're taking, we believe we can move the Company steadily forward over the coming two to three years toward our long-term financial goals.

You can see these financial goals summarized on slide 10.

In terms of revenue we want to grow our -- in our targeted focused areas at above industry average rates.

We believe we can exceed these industry averages because of our differentiators in such areas as security and outsourcing, and because of the strong commitment and focus we are placing on these markets companywide.

As we grow at these rates we expect to grow each of our focused businesses to at least 500 million in size by 2008.

Some areas such as outsourcing already exceed this size.

Our outsourcing business was $1.8 billion in revenue in 2005 and we expect to see continuing strong growth in this area.

In terms of margins, our goal is to achieve high single digit operating margins, excluding pension expense, by year end 2008.

So overall by 2008 we want to achieve the following financial goals, revenue growth of mid-to high single digits and overall operating profit margins excluding pension expense of between 8 to 10%.

We expect to move in a step by step fashion towards these goals over the coming years as we implement the actions I discussed including our cost reduction actions.

Turning to slide 11.

In 2006 we are looking for a transitional year with all of the changes we are making as well as potential cost restructuring charges, divestitures and a highly variable tax rate, we will not be giving quarterly or annual earnings guidance.

In terms of revenue, before considering the impact of any divestitures we expect revenue growth in the low to mid-single digits in 2006.

In terms of our individual businesses in 2006, we expect to mirror or exceed market growth rates for our focused growth areas of outsourcing, systems integration and consulting and ES7000 servers.

Similarly, we expect our ClearPath and core maintenance revenue to continue secular decline.

Overall we look for 2006 to be a rebuilding year that will give us the foundation we need to move forward toward our long-term financial goals in 2007 and 2008.

To summarize, please turn to slide 12.

We made good progress in the fourth quarter in repositioning Unisys for profitable growth.

We achieved our financial target for the quarter, improved our margins, delivered strong free cash flow, and closed the number of significant services in technology orders.

We implemented initial elements of the business repositioning plan that we outlined in October including focusing our services delivery force around our high growth markets, laying the foundation for our cost reduction and head count actions, marketing non-core areas for potential divestiture and enhancing our new sales and marketing programs.

I am encouraged by our improvements that we're making.

And I look forward to reporting on our progress over the months ahead.

Finally, before I turn the call over Janet I would like to welcome Rick Duques as the new Non-Executive Chairman of the Unisys Board of Directors.

As you may have read in our press release earlier this week, Rick has agreed to assume the position of Non-Executive Board Chairman as of February 1, 2006, taking over for Larry Weinbach, who is retiring as Board Chairman on January 31st.

Rick has been a member of our Board of Directors since 1998 and he has extensive experience in the IT services industry, and I am delighted to be able to work with him to achieve our strategic goals as we reposition Unisys as a more focused, profitable Company in the marketplace.

Also, I'd like to take a moment to formally recognize Larry Weinbach for his efforts and dedication to Unisys over the past eight years.

Since coming here in 1997 Larry has been a tireless advocate of Unisys in the marketplace.

I would like to thank him for his contributions in continuing the transformation of Unisys to a services led technology based firm.

And I and the Company wish him the best of luck in his future endeavors.

Now here is our CFO, Janet Haugen for a review of our fourth quarter results.

Thank you, Joe, and hello everyone.

Like Joe, I was pleased by our performance in the fourth quarter.

We showed improved execution in the quarter closing orders, achieving the high-end of our guidance and generating strong cash flow.

Now I'd like to provide details on our fourth quarter and full year 2005 results including our cash flow performance.

To begin, please turn to slide 13 for an overview of our fourth quarter results.

At the top line we reported revenue of $1.57 billion for the fourth quarter of 2005.

This was up 3% from the year-ago period.

Currency had a 2 percentage point negative impact on our revenue in the fourth quarter reflecting a stronger dollar against international currencies.

On a constant currency basis our revenue was up 5% in the fourth quarter, a good quarter.

On a pre-tax basis we reported fourth quarter 2005 income of 27 million.

This compares to a pre-tax loss of 90 million in the year ago quarter which included a pre-tax charge of 126 million to write off capitalized assets associated with one of our business processed outsourcing operations.

Our pre-tax profit of 27 million in the fourth quarter of 2005 includes 44 million dollars of pension expense.

This compares to $23 million of pension expense in the fourth quarter of 2004.

Excluding pension expense, we reported pre-tax profit of 72 million in the fourth quarter of 2005.

This was at the high-end of the 50 to $75 million guidance that we provided in November.

This compares to a pre-tax loss, excluding pension expense, of 67 million a year ago.

Again, the 67 million loss included the pre-tax charge of 126 million to write off capitalized assets associated with one of our VPO's.

Reflecting our geographic mix of income in the quarter, we had a tax provision of $58 million in the fourth quarter of 2005.

In the year ago quarter, we had a tax benefit of $55 million principally due to favorable tax settlements.

This resulted in an overall net loss of $31 million or $0.09 per share for the fourth quarter of '05 which compares to a net loss of 35 million or $0.10 per share in the fourth quarter of 2004.

Now note, as Joe referred to, as a result of the valuation allowance that we recorded in the third quarter of 2005 on our deferred tax assets, our book effective tax rate going forward will vary very significantly from quarter to quarter depending upon the geographic mix of our earnings.

I'd like now to provide for details on our fourth quarter results.

To start, please turn to slide 14 for an overview of our orders.

Overall, our orders in the quarter showed double digit growth compared to a year ago.

And we go forward into 2006 with a healthy pipeline.

Services orders were up double digit versus a year ago driven by the outsourcing wins that Joe mentioned earlier.

Just want to mention that included in the service orders this quarter is the TSA bridge contract for approximately $100 million reflecting only those task orders that we have received under the overall bridge contract.

In technology, as well, we showed single digit growth.

We ended 2005 with $6.37 billion of services backlog.

In addition, we end 2005 with $2.3 billion of unfunded U.S. government orders in backlog.

Moving now onto revenue in the fourth quarter, please turn to slide 15 for an overview of our fourth quarter revenue by geography.

Our U.S. revenue grew 4% and represented four -- 44% of our revenue in the quarter.

Revenue from international regions grew 3% and accounted for 56% of our revenue in the quarter.

Slide 16 shows our revenue by business segment.

Services revenue grew 1% in the quarter and represented 81% of our fourth quarter revenue.

Technology revenue grew 11% and represented 19% of our revenue in the quarter.

For more detail on our services revenue please turn to slide 17.

Within services we sold growth in outsourcing and infrastructure services.

This offset a 2% revenue decline in systems integration and a 13% revenue decline in core maintenance.

Turning to slide 18, in our technology business we saw an 8% growth in our enterprise server revenue reflecting stronger ClearPath sales which included several large transactions that we were able to close in the quarter.

We saw single digit growth in ClearPath sales in the fourth quarter and substantial double digit growth in ES7000 revenue.

Specialized technology revenue also increased in the quarter but was down for the full year.

I'd now like to summarize our full year 2005 revenue and how it breaks down by geography and by business segment.

Slide 19 shows our full year 2005 revenue by geography.

Overall, our 2005 revenue declined one point from -- from full year 2004 revenue.

And currency had a 1 percentage point positive impact on full year 2005 revenue.

Our U.S. revenue increased 1% in 2005 and represented 46% of revenue for the full year.

International revenue declined 2% in 2005 and accounted for 54% of our full year revenue.

Slide 20 shows our full year 2005 revenue by business segment.

Services grew 1% in 2005 and represented 83% of total revenue for the year.

Technology revenue declined 11% in 2005 and accounted for 17% of our revenue for the year.

Drilling down into our two business segments slide 21 shows our full year 2005 services revenue by component.

Outsourcing revenue grew 6% and accounted for 38% of services revenue.

Systems integration and consulting revenue was flat in 2005 and represented 35% of our services revenue.

Infrastructure services increased 3% in 2005 and represented 17% of our services revenue.

And finally, core maintenance declined 12% in '05 and accounted for 10% of our services revenue.

Moving to slide 22.

In our technology segment enterprise server revenue declined 10% in '05 and accounted for 81% of technology revenue.

Within enterprise sales -- oh, I'm sorry, within enterprise servers sales of the ES7000 servers were up low single digits for the year while ClearPath revenue showed low double digit declines for the full year of '05.

Moving on to slide 23.

Slide 23 shows our operating margins in both quarters.

Excluding the impact of pension expense, our fourth quarter 2005 operating margin was 5.2% in the quarter.

This compares to a negative 3.6% in the fourth quarter of 2005.

Now, that's included the write off, or the asset impairment charge, actually, for the business process outsourcing that we mentioned earlier, and that was the primary reason for the change year-over-year.

Slide 24 prepare -- provides a comparison of our services operating margin in the quarter.

Excluding pension expense, we had a 0.9% services operating margin in the fourth quarter of 2005.

The year-ago services operating margin was a negative 7.8% which included the business process outsourcing asset impairment charge.

Now moving onto slide 25.

In our technology business we reported an 18.7% operating margin excluding pension expense in this fourth quarter of 2005.

This compared to a technology operating margin, excluding pension expense ,of 12.8% in the fourth quarter of 2004.

The higher technology margins in the quarter were driven by stronger technology sales over a reduced operating expense base.

A few other notes on the quarter, on other income, in our other income and expense line which as you know can vary from quarter to quarter, we reported $10 million of other income in the fourth quarter of 2005.

That compares to other income of 6 million in the fourth quarter of 2004.

The principal reason for the change was the increase in the minority interest elimination of losses at iPSL.

As you know, we own 51% of this joint venture and fully consolidate the results of iPSL.

Though 100% of the revenue and costs are reflected in our income statement with an adjustment in other income and expense for minority interest.

That is, the joint venture partners 49% share of after tax gains or losses are eliminated through an adjustment that is reflected in the other income expense line.

Therefore, at the bottom line, only 51% of the after tax loss is he reflected in Unisys' results.

Now please turn to slide 26 for our cash flow and balance sheet highlights in the fourth quarter.

We generated $260 million of cash from operation in the fourth quarter of 2005.

This compares with $227 million of operational cash flow in the prior year.

This change was primarily due to improved receivables collections and the royalty payment received in the quarter from Nihon Unisys Limited, our joint venture in Japan.

Total capital expenditures in the fourth quarter of 2005 were $87 million, down from the 123 million in the year ago period as we reduced capital investments related to the business process outsourcing contracts and placed tighter controls over all other capital expenditures.

For the full year of 2005, capital expenditures were 382 million, down over 50 million compared to 434 million in 2004.

After deducting capital expenditures, we generated $172 million of free cash flow in the fourth quarter of 2005 compared to 104 million of free cash flow in the year-ago quarter.

For the full year 2005 we used $100 million of free cash flow compared to 36 million of free cash flow generation for the full year of 2004.

A few other notes on the cash flow and balance sheet, depreciation and amortization was 97 million in the fourth quarter of '05.

For the full year of 2005, depreciation and amortization was $374 million.

We ended 2005 with no borrowings against our revolving credit facility and with a cash balance of $643 million.

Now, lastly, just to comment on our defined benefit pension plans.

We will be reviewing with our Board alternative plan designs later in this quarter and we will discuss the results of those discussions after a decision has been made, so we will give you a future update.

Now, I'd like to turn the call over to Jack for questions.

Thank you, Janet.

Thank you, Joe.

Operator, we're ready to open it up for questions, please.

Certainly. [OPERATOR INSTRUCTIONS] And we'll go first to Jason Kupferberg with UBS.

Hello.

Mr. Kupferberg, your line is open.

Oops, I'm sorry, I was on mute.

Thanks for taking the question.

I just wanted to ask a question on operating margins looking out and I know you guys identified the 8 to 10% range for 2008 excluding pension expense and this year you're just giving top line guidance for now.

What's kind of a reasonable range to think about for '07 understanding that the full run rate of cost savings from the restructuring plan will not have kicked in as of '07 but just directionally what's the right way to think about where operating margins ex pension could go?

Well, let me first come back to this whole issue of guidance.

We thought long and hard about guidance before we made this decision, and it was a very tough decision for us.

And -- and I think you're probably also aware that one of the reasons that we believe it was the right thing to do was so much of what occurred in 2006 was divestiture and restructuring dependence so let me deal with those two first the I'll come back to your 2007, Jason, in a second because it influences it, depends on -- even in this year when -- when things occur.

The restructurings are largely dependent on our divestitures.

Our divestitures, and history has always shown that they always take a little bit longer than people expect and we don't always get the value that we hope for, and those two items are interdependent, how aggressive we want to go in timetable impacts our financial return.

But there's one other element there and that's tax rate.

So I just want to paint all of this as the context.

It's -- it's going to be very difficult if us in '06 to predict the geographies where this profit will be generated and therefore accurately predict our -- our tax rate.

That said, where the same things occur in the year 2006 what impacts 2008, obviously we would like to be as aggressive as we can and see if we could at least act on the full 250 million and 3,600 people as early in the year as we can, but we're not going to set expectations that way.

We're setting expectations that this is going to occur largely in the second half of the year and even within the second half we'll impact your -- your 2007.

Now, that said, we expect, because of in the services side of our business, to be so dependent on a combination of fixing the big PB -- BPO's, you've heard about one of them, we expect continuous improvement throughout 2006 on the second, but the other is our largest single issue in the services side happens to be in over capacity.

We've shared in the past that's the largest portion of that overcapacity is in Europe.

And -- and so let me add one other variable here.

And that is negotiating with our workers councils.

We -- we've already begun that work.

We began it in the fourth quarter.

We're continuing that work.

We have our largest payback periods for the people that we restructure in continental Europe as you might imagine even when we act here those payback periods are often 24 months.

So, I'm -- I'm not trying to be evasive on when these actually return in -- in 2007, but because a fair number of the -- the European actions have these close to two-year payback periods you won't always see the kinds of impact you would think that normally you'd start to see in the first half of 2007.

In some cases you'll see that impact in the -- in the second half of 2007.

So net/net we -- we expect an improvement in -- in operating margins before pension, and we expect a continuous improvement '06, '07, '08.

It will not be a straight line.

And I think that's the biggest issue that people have to recognize, and the second part being the ge -- geographic differences when those actions occur actually roll into the year 2007.

So you'll see a continuous stair step improvement over the course of the three-year period incrementally and you should see a fair stair step in 2007, but it might not be what you expect based on what occurs for us in Europe.

Okay, understood.

You had a nice quarter of award growth here in the -- in the fourth quarter.

Looks like the -- the new global marketing campaign is starting to have some favorable impact.

What's the right way to think about your expectations for '06 order growth just directionally in the context of the low to mid-single digit revenue growth expectation that you're putting out there?

It's a good question.

The largest drivers of our order growth is our outsourcing business and often our public sector business.

We feel good about those two businesses going into 2006.

I -- you've see the results in the fourth quarter which would obviously have impacts on our revenue growth in -- in 2006 and beyond and we -- and we feel good about that business.

We believe we're getting stronger and stronger in terms of leadership, success, win rates and so on in outsourcing.

We also feel strongly about our public sector business.

You saw not just federal this time.

You saw in the U.K. and other areas of the world a positive impacts, but you're -- you're -- I know you're also aware of what occurred in the fourth quarter of last year in the federal government about funding of various agencies, a lot of this work going on continuing resolutions, we expect to see a bounce back of that the first half of this year, and so I think those are the two areas that will drive our order growth, and you should see continued success in that area.

Okay.

Thanks for the color and good luck, guys.

Great.

Thanks, Jason.

And we'll go next to Julie Santoriello with Morgan Stanley.

Thanks.

Good morning.

Good morning.

Joe, wanted to ask you first about backlog.

I believe last year the end of the year about 6.8 billion, now you're around 6.3 or so.

Can you talk about some of the factors that affected that?

I understand that there is a large portion of unfunded backlog from the public sector business, but can you just help us understand the factors that drove that change, were any of the problem contracts in there?

Julie, I will defer to Janet for part of that and then I'll come back.

Julie, just want to comment that when you're looking at the backlog, while it does -- it is a decrease year-over-year, that decrease is really driven by currency, so you had the soft first half of this year with orders that we have discussed not refilling that backlog.

We gained momentum as we went into the fourth quarter with the wins that Joe discussed, and so we're coming out of the year on a constant currency basis with about flat backlog.

The second part of it and -- and it's partially my response to Jason's question earlier, Julie, is we're hoping for certain things to occur in public sector in the -- in the tail end of last year.

They didn't occur because of how the funding process works in the U.S. government.

It's not effected just us.

You can look at other major systems integrators in the U.S. federal government.

As -- as that changes and as each of these agencies and as you know we're almost equally split across the three major sectors in the U.S. government - homeland security, civilian and defense, we -- we see a bounce back across all three agencies.

Also if you heard earlier, how we book things effects that as well.

So, unless -- unless these areas of these contracts are funded, unlike many of our competitors, we -- we will not put it in the backlog.

And so I think you should see some improvement there in the first half of this year.

Okay.

Great.

Just kind of a strategic question, you've -- you've laid out a -- a very in -- in -- intensive plan for reorganizing the company.

Clearly well -- well thought through.

How, Joe, though do you manage going to this reorganization, this restructuring versus growing the business and keeping the business competitive?

And -- and I guess part of what triggers this question is looking at your CapEx decline and I think commentary that you're freezing some -- some CapEx investments, so how do you sort of balance the growth through the restructuring phase?

Julie, it's a great question.

Let me deal with the last part of your question first.

We -- we actually because of our decline in CapEx, or you looked at it it and thought maybe we walked away from certain business we didn't.

We've been much more aggressive in directing our field into how they structure contracts.

You might -- you might make an argument, geez, you guys should might have -- or should have done that all along, but the market's changing there.

We're changing with it.

You're seeing much less capital required in a number of these contracts, but we're also being much more disciplined in our field approach and how it gets structured around prepayments, and -- and what things we carry through the contract in some cases.

We might actually direct a client not to put commodity third party through this even though they may wish to because they would like one single vendor to hold accountable and potentially one throat to choke, and so we've -- we've been more aggressive in -- in directing both our field organization and trying to guide our clients in that area, so you haven't seen any loss of business there.

But your other question is a real challenging question.

And -- and that is how -- how do you get the right focus on both ends of this?

One part of this is real cost reduction.

And aggressive cost reduction and reengineering around nearly every element of our business and the other part is -- is driving the growth.

I mentioned earlier the integrated horizontal competency center will be one major center of that.

But let me build upon that.

We've organized our Company around the growth areas, so whether it be sales and marketing and Peter Blackmore's area in a integrated program office across each of the growth areas, we've asked each of the program and marketing areas of each of the business units to reorganize around the growth areas.

You've heard horizontal competency center has reorganized around the growth areas and we're making investments in training even though across SG&A, and G&A, specifically we're taking costs out and so the answer is we're putting equal focus on both.

We succeeded in doing that in the fourth quarter.

I'll give you one example.

We -- we -- for -- for the most part with certain rare exceptions held costs, focused the field on cash collections so we ran a much more efficient operation and got the growth.

So, it may at first glance appear difficult.

It is.

It's challenging when you're focusing people both on taking costs out and in a fairly unforgiving way and reorganizing around growth areas, but as of now, we've been successful.

We actually have a program office that the entire executive committee participates in every week for two hours every Friday to measure the first half of meeting is all around the cost reduction and the second half of the meeting is all around reorganizing for growth.

And so we've got the entire attention of the leadership team of our Company in doing this.

You're right.

It -- it might at times appear that people could be schizophrenic about doing both.

We got their attention and we believe we're on the right track.

Very helpful, Joe.

Thank you.

If I can get one more quick one on the revenue growth.

You talked about in your key focus areas growing faster than the industry average rates.

And you highlighted the -- the rates that you would look at in outsourcing system integration and consulting and the ES7000.

Can you share with us what you see as -- or what sources you're looking at for those market rates?

There are a few of them out there just to help us kind of get a starting point.

Another great question.

We -- we actually combined work we do from the security analyst community, Gartner, IDC and others to create our own, even though we have a great deal of respect for Gartner and IDC, very often the backward looking is much more accurate than their forward-looking outlooks, and they often extrapolate from the past.

But, that said, when we triangulated systems integration for us and -- and -- and this is actually been tempered just recently by some of the surveys we've gotten out of the major security analyst firms.

SI originally was mid-single digit.

It's been tempered down recently to mid -- sorry, low to mid-single digit which is a recent thing, so if you were to look at the last Gartner IDC triangulation you would have said mid but it's now low to mid.

In outsourcing it's generally mid to high depending on how you look at .

In -- in our ES7000 it's on a seam if you look at Gartner and IDC between mid-range and high-end, and the reason I say that is they have -- they draw lines by the average selling price as opposed to any particular co -- configurations so some of our business is above that and some is below it, and -- and so -- so it's a bit of a hybrid number, but that's high single digit to low double digit because one of them is below it and one of them is high.

And so it's a blend issue, and in our -- our high-end proprietary business if you triangulate between the various market research companies you'd find it's in secular decline somewhere between mid to high single digit to very low double digit.

I know that's not a specific as you might like, but again we're triangulating among others and -- and that's where we came out.

That's great.

Thank you, Joe.

Great.

Thank you.

And we'll go next to Julio Quinteros with Goldman Sachs.

Good morning, guys.

I guess my question -- my first question relates to the -- the long-term targets as far as the model is concerned.

Underlying your assumptions, what is the -- the hardware and services mix that we can expect as we look out to '07 and '08 relative to the -- to the long-term model mix that you're talking about?

I'm sorry, Julio.

You have to repeat the question because I wasn't sure exactly what you meant.

Julio, are you asking that as we -- as we go for the long-term model we've given you overall targets.

You asking what percentage of the revenue comes from services and what comes from hardware?

Exactly and -- and/or profits.

Okay.

Obviously, that depends upon where the market conditions are.

Joe's got -- Joe's outlined what we expect to see in -- in the marketplace.

As you look at our technology business, as we disclosed, 81% of our revenue comes from our enterprise server area.

We've got a significant portion of that that's declining as Joe talked about from a market trend and the ES7000 growing.

So based upon that dynamic and how our revenue splits between services and technology, services having the higher growth rate you would expect to see that grow as a percentage of our revenue.

But -- but still technology being important as we go forward.

Okay.

I guess I'm just looking at this quarter where 80% plus of the profits came from the technology side, should we expect that same type of model mix?

Ultimately what I'm trying to get a sense of, because you guys have talked about having already identified some of the pieces that you plan on selling so I'm just trying to sort of come around -- roundabout way of looking at what -- what this business model is really going to look like both from a services and technology platform assuming that the -- the divestitures takes place this year.

Yes.

That's what I thought you were first going on that.

And -- and it would be pretty easy for me to tip my hand in things that we -- we might divest that we weren't prepared to go public about, and so you're absolutely right.

Your intuition which is potential divestitures could change that mix over time, that's true, but we're not in a position to share that with you.

But the other issue that which was the -- I -- I think the services gross margin piece, there's -- there's a very big piece of that that is over capacity.

As we right size the service organization, now remember, the same calendarization issue that I talked through with Jason is there in terms of what's the pay -- payback period and the return it might be six months in the U.S. and it might be 24 months in Europe.

That said, that will have a very, very big impact on our business if we're going to take out 125 million in costs and service that essentially flows right to the bottom line.

That is -- that is pure under utilization.

Again, you can add to that, continuous improvement in the outsourcing business, but and then some -- some steps like this latest step we took with iPSL, which we're prepared to share with you how much impact that'll have which would be low 30 million because it -- we -- we'll be reporting it in our -- in 10-K.

And so it is continuous improvement in outsourcing, an elimination of over capacity, which is a very significant problem for us,in -- in in our whole systems integration business, and the impact of pooling which we haven't figured into many of these equations.

When we move to pooling and we retrain these people with much greater critical mass focused on only the high growth areas of the business, and -- and we can -- we can share with you but it's -- it's based on the same external growth rates for security and the Microsoft end of the business, Linux and Open Source they are all growing it at mid to high double digit rates.

It's a combination of growth, it's a combination of taking people off it's and a combination of higher utilization of our existing population and you should see real improvement in -- in operating margins and services as a result.

Okay.

Appreciate that.

And I guess just as a quick follow up, for Janet, I didn't hear you talk about potential pension expenses for calendar year '06.

Is that just because you guys are looking at a pen -- at the pension plan as well, still?

Yes.

Let me jump in and then -- and then I'll ask Janet to help with specifics if you require them.

We have clearly watched IBM, Hewlett Packard and others in our segment.

We recognize the impact that it has, the drag it has on our business overall.

But -- as we worked through this we've done it in a very careful thoughtful way including looking at our employees, retention, morale and those types of things.

But we clearly understand the competitiveness of this.

And so, Janet mentioned in her comments that we are bringing our final analysis to our Board later this quarter, and we expect them to take an action on it.

Okay.

So there's no visibility on -- on the quarter sort of run rate in terms of pension expenses for '06 at this point?

No, Julio, we think those -- that depending upon what's decided could have a significant impact on that -- could -- there are a number of various alternatives we're looking at and we think it's too premature to give you guidance on that right now.

Okay, great.

And then maybe just as my final question, related to the divestitures again without obviously going through the specifics of what you're planning on divesting.

I guess I'm trying to get a sense on the divested lines that you've identified.

Are these positive to cash flow contribution, either from sort of I guess from a free cash flow perspective and a capital -- and a capital expenditure perspective, are these also capital intensive assets"

The-- the answer is some and some.

It -- remember back to our original filter, we were looking for businesses that we believed could grow ideally double dig -- digit growth rate.

They could -- this is our model, right, and how we got to outsourcing and security and so on.

Double digit revenue growth grow to a minimum of $500 million business by 2008 and so on.

You yourself can parse through our businesses and figure out which ones could -- could hit that threshold or not.

That said, some of these businesses are -- are attractively profitable, others are marginally profitable.

Some generate cash, others don't.

Some are accountable for CapEx and some aren't.

So, I know it's -- it's not the answer you're looking for, but it is all over the map, and if we were very specific, you could clearly identify them.

I guess -- I guess at the end of the day will the divestitures improve the free cash flow profile of the Company or not?

Well -- weel, Julio, the divestitures by themselves are going to be used to fuel the cost reduction actions that Joe mentioned and those cost reduction actions at $250 million are significant annual expenses coming out of the business so by that nature that will improve the cash flow.

Okay.

Great.

Thank you.

Great.

Thank you.

And due to time constraints we do have time for one final question, and that question comes from Jennifer Dugan with Merrill Lynch.

Thank you.

My question is regarding your renewal of the TSA contract.

How did the new terms compare to the old in terms of revenue and margins potential?

It broke up on our end.

Could you just repeat the last part of that.

I was wondering how the new terms on the TSA contract compare to the old, looking at -- at the revenue being generated and the potential margins?

Jenny, the -- the TSA bridge contract as we talked about in the release is a continuation of the same type of critical services that we've been providing for the agency, and -- and run consistently with what we had been experiencing previously.

Don't really comment on the profitability or the range of contracts, but of each a specific contract, but it is not outside of -- of what we're experiencing.

And now the one important thing that we did disclose and was in Joe's comments as well, the TSA contract previously had commodity hardware in it.

And if you followed how that TSA contract went in our historical results you would at times see a peak in the revenue particularly in the early years when that hardware would come in with very minimal margin at the bottom end.

That -- that is not in the current contract, so we're pleased that the elements of the contract that continue forward with those pieces that we believe we provide true value add and support the critical mission of the TSA contract, and the commodity hardware which was really prevalent in the earlier stages of the contract and you could hear -- we -- we discussed that in the early quarters, the -- when it would peak, when we would have some type of a deployment of a -- a communic -- of a -- some kind of a device or technology, those obviously by the nature of being commodity have very minimal margins on it.

Okay.

Great.

Also looking ahead to the next couple of quarters, do you expect kind of that your normal, the tech notice division to follow it's -- it's normal seasonal pattern, or is there some momentum maybe following through from four Q4?

As -- as I mentioned earlier, we -- we believe we'll see continuing momentum in -- in two of our growth businesses, outsourcing, and in -- in our public sector business.

But our seasonality won't be terribly different from what you expect in the past.

So, yes, there's areas that we believe we can -- can continue to build on momentum, but the -- the general background model would be essentially the same.

And on the technology side as well, where there's a lot more seasonality?

Yes, well that --that's precisely what we're talking about.

Because it's most impacted by technology.

Okay.

Great.

Great.

I want to thank all of you very much.

I -- I will tell you we are excited about the balance of this in the fourth quarter across, as Janet mentioned earlier, multiple geographies, multiple businesses.

I know that there was -- very important for all of us to begin to execute including all areas of this business and cash flow, and so very proud in terms of the -- the order growth, the cash flow, and -- and our act to execute.

So thank you very much.

And this does conclude today's conference.

Thank you for your participation.

You may disconnect your line at this time.