Unisys Corp (UIS) 2006 Q2 法說會逐字稿

Good day everyone and welcome to the Unisys second-quarter 2006 financial results conference call.

Today's conference is being recorded.

At this time for opening remarks and introductions, I would like to 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 second-quarter 2006 financial results and with us this morning to discuss our results are Unisys' CEO Joe McGrath, and our Chief Financial Officer, Janet Haugen.

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

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

This webcast including the question-and-answer session is being recorded and will be available as a replay on our website shortly after the conclusion of the live event.

Second, you can find on our investor website earnings the release and the associated spreadsheets as well as presentation slides that will be used during this morning.

You can use these as we go through the discussion.

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

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 in the Company's periodic reports as filed with the SEC.

Copies of these SEC reports are available from the SEC and also from Unisys' investor website.

Finally I just want to mention that we had a severe thunderstorm here in the Philadelphia area last night.

We have about 500,000 people in businesses that still don't have power.

So we are actually running on a generator here.

The system seems to be working fine but if you do lose us during the call, please stay on the line and we will dial back in and hopefully everything would be fine.

Our backup case if this really does go down is to really we will post Janet and Joe's comments on the website and then we will have to take individual questions from you during the day.

We do not expect that to happen but just to let you know.

So let's get started.

I will now turn the call over to Joe.

Thank you.

Great.

Thanks, Jack.

Hello everyone and welcome to today's call.

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

This was a mixed quarter for Unisys.

If you have been following Unisys in recent quarters you know that we have been working through a broad-based repositioning of the Company from our strategy and sales approach to our solutions portfolio and cost base.

We continue to make significant progress in implementing this plan.

In the second quarter of 2006, our primary focus was executing our cost reduction program which is critical to reaching our 2008 financial targets.

As I will discuss later in my remarks, we moved aggressively to implement initial headcount reductions while also identifying additional opportunities to streamline our operations.

Overall we are now in the process up implementing some 5500 headcount reductions around the world.

This is significantly higher than our original expectation in late 2005 and we expect these actions to yield net annualized cost savings in excess of $325 million by the second half of 2007.

With all the changes we are making in the business we did see an impact and disruption in our financial results in the quarter.

However, we are confident that the repositioning efforts will significantly enhance our profitability and competitiveness over the long term.

This morning I would like to update you on where we stand in our repositioning program and in particular our cost reduction efforts.

I will talk about approaches we are taking to reduce our labor costs and improve our margins.

Before I move into the repositioning program, please turn to slide two for an overview of our results in the quarter.

As I mentioned, our second quarter financial results were impacted by disruptions in the business as we worked through our repositioning actions.

After two consecutive quarters of double-digit order growth, our second-quarter orders were down double-digits from a year ago.

Orders were down for both services and technology.

Our overall revenue was down 2% in the quarter.

Services revenue declined 1% in the quarter while technology revenue declined 8%.

The lower-than-expected sales volume impacted our margins in the quarter particularly in the technology business.

In the second quarter we made some major new announcements in the technology business to drive demand and we expect that these initiatives along with our cost reduction programs will improve results in our technology business in the second half of 2006.

I will talk more about our technology initiatives in a few minutes.

Overall, including a $141 million restructuring charge that we took for headcount reduction we reported a $194.6 million net loss for the quarter.

We continue to look for 2006 overall to be a transitional year as we implement the changes in our business.

As our cost reduction actions take hole, we expect to begin seeing continuous declines in our cost structure starting in the third quarter.

Our Chief Financial Officer, Janet Haugen, will provide more financial details about the quarter in her remarks.

Let me mention that although overall orders were down in the quarter we did win some significant awards in our focused areas of growth.

In the area of security, for example, Unisys was selected by the Department of Homeland Security as a prime contractor under the DHS EAGLE Program.

This is a very significant win for Unisys building on the successful relationship we've had with DHS and the Transportation Security Administration over the past four years.

Unisys was selected as a prime contractor in two functional areas of EAGLE, IT infrastructure design and deployment and system operations and maintenance.

By being selected under this program, Unisys will be able to compete in these areas for future task orders.

We also continued to enhance our leadership team for the Company.

During the second quarter we successfully recruited Brian Maloney to head our global industries business.

Brian has an outstanding track record of success at Perot Systems, AT&T Solutions and other leading IT services organizations and we expect him to make a positive impact in our repositioning plan and line of business practices which are so critical to our differentiation and success in the market.

We also strengthened our global leadership team with the addition of Nick Wilson who joined us to run the UK, Middle East and Africa business.

Nick came to us from IBM where he was General Manager of the global services business in the UK, Ireland and South Africa.

Now please turn to slide three for an update on our repositioning program.

As you will recall from our previous conference calls, we are focused on achieving financial goals of mid to high single digit revenue growth and an 8% to 10% operating profit margin excluding retirement related expenses by 2008.

To reach these goals there are three broad areas we're making changes in the business.

First, we are driving profitable topline growth by focusing our resources and investments on a handful of high-growth markets while divesting or deemphasizing non-core businesses.

Second, we are changing how we market, sell and deliver our solutions portfolio in the marketplace to improve productivity and utilization.

Third, we are rightsizing our cost space and significantly reducing expenses to reflect our more focused business model.

We made progress in all three areas in the second quarter.

In particular, we made significant progress in the quarter on our cost base and I'd like to focus my remarks on this area this morning.

Transforming our cost base is critical to reaching our financial goals for 2008.

Slide four shows the key drivers to reaching our operating margin target in 2008.

As we work toward the 8% to 10% operating margin target for 2008, we expect more than half of that margin improvement will come from cost reduction activities.

The rest of the margin improvement will come from expanded use of global sourcing, attrition management, improvements in our challenging outsourcing contracts and revenue growth.

Offsetting some of these positives to margins over this time period will be increased investments that we're making in our growth initiatives, global sourcing and employee development as well as continued secular declines in ClearPath and Core maintenance.

So getting our cost structure right will be critical to our success not only in reaching our financial goals but also in ensuring our competitiveness in the highly competitive IT industry.

During the second quarter we continued to rigorously analyze our global operations for opportunities to lower our cost of labor and reduce or eliminate overhead.

We also continued to reengineer processes using our ongoing Six Sigma Lean program.

We currently have more than 100 Six Sigma projects underway throughout the Company to drive change and reduce costs.

Throughout this work, we have identified greater than expected opportunities to reduce our global headcount and in some cases to shift work to offshore locations.

You recall that last quarter we announced a $145 million charge for 3600 planned headcount reductions.

With the restructuring charge we took this quarter we are targeting another 1900 headcount reductions, about 150 of those reductions are planned for Continental Europe, the remainder from other geographic regions around the world.

Largely because of the European component, this round of reductions will be more costly to implement than the first round of reductions but they will add to the overall savings we're expecting from cost reduction activities.

So overall through these two structuring actions, we expect to reduce our gross headcount by some 5500 positions worldwide.

Slide five shows more details on the expected timetable for the headcount actions and our expected cost savings.

We completed about 2200 reductions in the second quarter.

We expect to complete another 1300 in the third quarter and about 1500 in the fourth.

So we expect about 5000 reductions or 90% of the total reductions will be complete by year-end 2006.

In the first half of 2007 we plan to complete the remainder of the headcount actions.

We expect these headcount actions to substantially reduce our cost base at the same time we are reinvesting some of these cost savings into funding our growth initiatives, building out our resources in offshore locations and investing in employee development.

I'll talk more about these reinvestments in a minute.

Netting out these increased investments against our total cost savings from the headcount actions, we expect to reduce our annualized cost base by about $280 million by the end of 2006 and by more than $325 million by the second half of 2007.

Moving to slide six.

Let me briefly discuss the important investments we're making in global sourcing.

As we reengineer processes and workloads throughout the Company, we are accelerating our use of global sourcing.

We have set aggressive and mandatory targets for all of our businesses in terms of making it use of offshore resources.

We are also carefully managing our attrition to make sure that appropriate positions that come open are filled through our offshore centers.

As you may know, we opened a global sourcing center in Bangalore in 2005 and this center is now nearly fully staffed.

We are opening a second center in Bangalore later this summer.

Over the past six months we have also announced global sourcing centers in China and in Hungary.

Currently we have about 1800 resources in low cost countries primarily in India with about half of those being direct Unisys employees.

We expect to grow the number of Unisys offshore resources in India, China and Eastern Europe to more than 6000 by 2008.

In addition to expanding our global sourcing operations, we are making investments in other areas to reengineer processes and reduce costs.

Throughout the Company we are benchmarking our processes against the best in class in the industry and we are taking actions to achieve a world-class cost structure for our business.

So overall we are moving aggressively to implement our cost reduction program while expanding our investment in global sourcing and other programs.

We are ahead of plan in terms of global headcount reductions and we expect these initiatives to significantly enhance our profitability and our ability to compete over the long term.

Let me add that even as we implement and complete the actions I have just discussed we are not finished with cost reduction.

We are exploring other approaches to streamline our cost structure including taking a hard look at our facility costs.

We hope to be able to report additional cost actions later in 2006.

Turning to slide seven.

I would like now to discuss some important initiatives in our technology business that we took during the second quarter.

As you know over the past year or so, we have been experiencing weakness in our technology business in particular in sales of our ClearPath mainframes.

Sales of ClearPath systems slowed and showed double-digit declines in the second quarter and contributed to the sharp margin decline in our technology business during the quarter.

To drive improved demand in our enterprise server business we made major announcements in our technology business late in the second quarter.

For a number of years now we have been steadily shifting the focus of our technology resources and investments to value-added software such as the ClearPath operating systems and innovative systems management tools and middleware.

At the same time we've been moving our hardware environment to industry standard technologies to take advantage of commoditization and lower costs.

In the second quarter, we announced a next generation Unisys enterprise server architecture that will bring this vision to fruition.

The new architecture uses innovative Unisys software that will over time enable all of our enterprise server lines to run on a single common architecture using standard Intel chips.

The new architecture will be able to run up to four operating systems, that is our two core path lines as well as Microsoft or Linux systems simultaneously on the same mainframe class Intel-based environment.

Using Unisys software, the system will be able to dynamically allocate computing resources among these environments in real-time based on business need.

Other enterprise server providers have been talking about such a real-time infrastructure, Unisys will be the first to deliver on it.

During the second quarter, we laid out a clear technology roadmap for our enterprise server customers that will take them to this new environment.

You can see this depicted in slide eight of the presentation material.

At the left, you see the ClearPath in the current stage of its evolution.

Current versions of ClearPath allow clients to run multiple operating systems on the same platform using physical partitioning with ClearPath operating system running a proprietary CMOS chips and Windows or Linux running on Intel partitions.

The second phase shown in the middle reflects the first generation of a complete Intel implementation.

In this platform both sides of the house proprietary ClearPath operating systems and open Windows or Linux systems, run entirely on Intel in a physically partitioned environment.

We will begin shipping entry-level systems of this generation of ClearPath in the first half of next year with additional operating environments and performance enhancements being released through 2007 and 2008.

The third phase on the right side of the chart takes the architecture fully into the real-time virtual infrastructure.

Through innovative Unisys virtualization and systems management software all operating environments dynamically share workloads and processing capability without the need for physical partitions.

We expect to begin shipping initial ClearPath models on our joint Unisys NEC developed platform in 2008.

To deliver on this technology roadmap, we are leveraging our partnership with NEC and Intel.

By taking advantage of advances in Intel processing power, we will be able over time to eliminate the need for custom CMOS processing chips reducing hardware R&D costs.

We will also be able to further reduce costs by shifting the manufacturing and assembly of the new systems to NEC.

Our message to clients in laying out this roadmap is clear.

Unisys is committed to our ClearPath customers and we are ready to work with them when and where they want to move to new platforms while continuing to support their existing applications and providing the kind of mainframe attributes they've come to expect from Unisys.

Also during the second quarter we announced a new high-end product family in both ClearPath families, the OS2200 and MCP.

The new models include some of these new software features I just described while offering up to 40% performance increases over previous systems.

Clients have responded positively to these new architecture and ClearPath models.

We expect the new ClearPath features and platforms to help improve demand in our technology business in the second half of 2006 compared to the first half of 2006.

Longer-term, we believe the new roadmap and architecture that we announced this quarter will help reintegrate our technology business and strengthen our competitive position in the enterprise server marketplace.

Turning now to slide nine.

In summary, during the second quarter we continued to make progress against our repositioning program; we moved aggressively to implement our cost reduction program; and we are targeting a higher number of headcount reductions than our original plan.

We will continue to focus on implementing the cost reduction programs in the third quarter and we believe that by the second half of the year we will have significantly reduced our cost base.

Also in the second quarter we made important announcements in our technology business aimed at driving demand for our enterprise servers.

I look forward to continuing to update you on the progress of our repositioning efforts as this year continues.

And now here is our CFO, Janet Haugen, for more details on our second-quarter results.

Thank you, Joe, and hello everyone.

This morning I would like to provide more details on our second-quarter 2006 financial results including cash flow.

To begin please turn to slide 10 for an overview of our second quarter results.

At the top line, we reported revenue of $1.41 billion for the second quarter of 2006.

This was down 2% from the year-ago period.

Currency had a negligible impact on our revenue in the second quarter and based on the current rates right now we would expect currency to have about a 1 point positive impact on our third-quarter 2006 revenue.

During the second quarter we recorded a pretax charge of $141.2 million for the cost of additional 1900 headcount reductions as part of our repositioning efforts. 750 of the 1900 headcount reductions were in Continental Europe.

Including this charge, we reported a second-quarter 2006 pretax loss of $203.5 million which compares to a pretax loss of $39.8 million in the year-ago quarter.

With regard to taxes, as we have said previously our tax rate will vary significantly quarter to quarter depending upon the geographic distribution of our income.

In the quarter we had a tax benefit of $8.9 million compared with a tax benefit of $12.7 million in the year-ago quarter.

Including the restructuring charge, we reported a bottom-line net loss of $194.6 million or $0.57 per share.

By comparison in the year-ago quarter, we had a net loss of $27.1 million or $0.08 per share.

To look at the detail of the restructuring charge, please move to slide 11.

This shows you how the charge flows through the P&L.

This slide also shows the P&L details on pension expense in the quarter.

With regard to pension expense as you know in recent years due to the significant volatility in pension expense from period to period, we have been providing non-GAAP financial statements showing our results both before and after pension expense.

As a result of making the changes in our U.S. defined benefit pension plans that we announced in March and as a result of remeasuring our U.S. plans at March 31, 2006, worldwide pension expense for this quarter and for the remainder of 2006 is not expected to vary significantly from the prior year comparable period.

As a result we will no longer provide separate financial statements showing our results both with and without pension expense.

Turning to slide 12, worldwide pension expense for the June 2006 quarter was $40.5 million compared with $45.8 million for the June 2005 quarter.

Full-year pension expense for 2006 is currently expected to be approximately $135 million compared with $181 million in 2005.

The principal reason for the 2006 decline is the $45 million curtailment gain which we recorded in the March first quarter 2006 quarter.

Now turning to revenue in the second quarter, please turn to slide 13 for an overview of our second-quarter revenue by geography.

Our U.S. revenue declined 6% in the quarter and represented 45% of our revenue in the quarter.

Revenue from international regions grew 2% and accounted for 55% of our revenue in the quarter.

Moving to slide 14, which is our revenue by business segment, services revenue was down 1% in the quarter and represented 87% of our second-quarter revenue.

Our technology revenue declined 8% in the quarter and represented 13% of our revenue in the quarter.

For more detail on our services revenue, please turn to slide 15.

Within services we saw revenue growth in infrastructure services and in outsourcing.

Growth in these areas was offset by revenue declines in systems integration and consulting and the secular decline in core maintenance.

Turning to slide 16.

In our technology business, revenue from enterprise servers declined 12% in the quarter and within enterprise servers, ClearPath revenue showed double-digit declines while the ES7000 revenue grew single digits over the year-ago quarter.

Moving to our segment margins, please turn to slide 17 for a comparison of our segment operating margins.

Just as any way of reminder, we have a long-standing policy to evaluate our business segment performance on operating income exclusive of restructuring charges.

So when I talk about the segment margins, they exclude the impact of the restructuring charge.

In services, we reported an operating margin of -0.9% in the quarter.

This was an improvement over the year-ago services operating margin of -3.7%.

We continue to face weakness in our technology business.

In the technology segment, we reported a -12.2% operating margin in the second quarter of 2006 which compares to a -4.8% in the second quarter of 2005.

We just make a comment on other income and expense.

Other income and expense which you know can vary from period to period, was an expense of $700,000 in the quarter compared with income of $32 million in the year-ago quarter.

The decline was primarily caused by two items.

The first, as a result of our first-quarter sale of our NUL investment we no longer have equity income from this investment.

In the second quarter of 2005, our NUL equity income was $16 million.

We should comment that that NUL income equity income.

For those of you who have followed us, you know in prior years it varies from quarter to quarter and for the full year the NUL equity income in 2005 was $9 million.

The second item causing other income to decline relates to the minority shareholders' portion of iPSL results.

In this area, improving the results causes other income to go down because of the accounting for minority interest.

So as a result of the improvement in the iPSL operating results, other income declined by $10 million reflecting the shareholders' portion of the iPSL results.

Now please turn to slide 18 for an overview of our cash flow and balance sheet in the second quarter.

We used $193 million of cash from operations in the second quarter out 2006 compared with $64 million of cash provided by operations in the second quarter of 2005.

Our second-quarter 2006 operational cash use included $34 million of cash payments related to restructuring action.

By comparison in the second quarter of 2005, our cash from operations included $20 million of cash payments related to restructuring.

Total capital expenditures in the second quarter of 2006 were $65 million down from $112 million in the year-ago period.

The principal decline was in outsourcing capital expenditures which can vary depending on new outsourcing projects and other property additions.

We have previously spoken to you about the fact when we are entering into outsourcing contracts we also review the cash flow and frequently receive cash deposits and prepayments on those contracts which are used to offset the capital expenditure requirement.

So similarly in the quarter we saw a reduction of about $67 million in customer deposits and prepayments compared to a year-ago quarter.

Just some other items to mention in the quarter on cash, we reduced by approximately $73 million the amount of receivables sold through our U.S. securitization program.

And we also repaid our debt in the quarter.

We repaid $57.9 million of our 8.125 percentage senior notes due June 1, 2006.

From a comparative standpoint, I'd like to point out that in the second quarter of 2005 we did receive the $39 million tax refund that was expected and announced that funded our prior restructuring program.

After deducting capital expenditures, we used $258 million of free cash in the second quarter compared to a free cash usage of $48 million in the year-ago quarter.

Depreciation and amortization was $93 million in the second quarter of 2006.

And for the full year 2006, we expect depreciation and amortization to be in the 370 to $380 million range.

We ended the quarter with a cash balance of $655 million.

Now I'd like to provide an update on cash requirements for the headcount reductions that we are implementing.

As Joe mentioned, we are taking actions to reduce our global headcount by a total of approximately 5500 positions.

Most of these reductions will occur in 2006.

The restructuring charges that we have taken relate to headcount and accordingly are all cash items.

There are no non-cash items in the restructuring charge that we have taken in the first or the second quarter.

We expect to use approximately $150 million of cash in the second half of 2006 for the headcount reduction and the majority of the remaining portion to be used in the first half of 2007.

Finally I'd like to take a few minutes to update you on our outlook for retirement related expenses.

The expected retirement related expenses as you know are based on actuarial assumptions and assumptions with regard to interest rates and currency exchange rates all of which are subject to change.

As I mentioned before, you recall that in the first quarter of 2006 we announced the adoption of significant changes to our U.S. defined benefit pension plans as we shift away from defined benefit plans to defined contribution plans which are more predictable in terms of expense level.

At the end of 2006, we will stop future accrual of benefits for the U.S. defined benefit pension plans and we will increase the matching contribution on our U.S. defined contribution plan from 2% of pay to 6% of pay.

As a result of this announced change to our U.S. pension plans, we have conducted an actuarial remeasurement of our assets and liabilities on these plans and we have also updated our expected retirement related expense levels for 2006, 2007 and 2008.

In addition, as we previously reported, the changes and the U.S. plans are part of a global effort by the Company to control the level and volatility of retirement costs.

All the estimates that I will discuss for 2006, '07 and '08 are based on current plan design.

The table on slide 19 shows our overall retirement related expense from the period of 2003 projected through 2008 based on current environment and current assumptions.

As you can see in this table because of the change in our U.S. pension plans and other factors such as higher discount rates, we expect our overall pension expense to decline significantly over the coming years.

This will be driven by a swing in the U.S. pension plan from pension expense to pension income in 2007 and 2008.

At the same time, as I mentioned earlier, retirement expense related to the U.S. defined contribution 401(k) plan will increase in 2007 and 2008 due to our increased match on our 401(k) plan.

For a graphical breakdown of the change in expected worldwide pension expense, please turn to slide 20.

The chart on this slide shows overall expected worldwide pension expense based on current assumptions.

Pension expense peaked in 2005 at $181 million.

In 2006 including the $45 million U.S. pension curtailment gain that was recorded in the first quarter, we expect total worldwide pension expense of $135 million.

Including U.S. and international pension plans, we expect total worldwide pension expense to decline to $62 million in 2007 and then to $25 million in 2008.

Slide 21 shows our overall expected retirement related expense which includes the worldwide pension expense as well as the U.S. defined contribution 401(k) plan expense.

As you can see, we expect the decline in worldwide pension expense, which I just discussed, to be partially offset by the higher expense for the U.S. 401(k) plan.

In 2006, we expect $19 million of expense related to the U.S. 401(k) plan which is flat from 2005.

For 2007, we expect the U.S. 401(k) expense to increase due to the increased company match from 2% of pay to 6% of pay.

We look for approximately $59 million of U.S. 401(k) expense in 2007 and since that is a more predictable pattern than defined benefit expense, we expect the U.S. 401(k) expense to remain at approximately 59 to $60 million in 2008 assuming that the employee population in the geographic makeup of that remains how it will be after the headcount reductions, the 5500 headcount reductions we discussed, are implemented.

Overall including the worldwide pension and the U.S. 401(k) plan expense, we look for total retirement related expense of $154 million in 2006 declining to $121 million in 2007 and then to $85 million in 2008.

I do want to just remind and caution that these estimates are based on the current interest and economic environment; they reflect our best assumption of today's environment with regard to discount rates, interest rates, actuarial assumptions.

All those things are volatile and could significantly change this expense going forward but we wanted to provide you with our best estimate right now of these expenses as we look out into a '06, '07 and '08.

In closing, let me just conclude with the commentary about our cost reduction expense.

Along with Joe, I am very pleased by how aggressively we implemented the cost reduction program during the quarter.

You can expect that as a Company we will continue to have that aggressive focus on reducing our costs.

I know we have a lot of hard work ahead of us but we will continue to focus aggressively on implementing the cost reduction program during the remainder of 2006.

Now I would like to turn the call back to Jack for questions.

Thank you Janet, thank you Joe.

Operator, we are now ready to start the question period please.

(OPERATOR INSTRUCTIONS) Julie Santoriello with Morgan Stanley.

Thanks, good morning.

Joe, I wondered if you can comment a bit on the order situation in the quarter?

I understand orders being down in the quarter as you are so focused on the restructuring and so on.

But orders were actually pretty good in the first quarter and that was still obviously a strong restructuring planning quarter.

Was there anything specific that happened in the second quarter in terms of your customer base, the market in general or your sales force?

Yes.

Julie, actually it was two back-to-back double-digit revenue -- order quarters.

As you know in the outsourcing business it is lumpy.

And if one or more, based on our size, significant deals push out of the quarter that is enough to make a difference for us.

And in our case that is precisely what happened.

In the second half of the year we expect to return to double-digit order growth in both the third and the fourth quarter.

So we really believe that the second quarter for us is an anomaly.

Remember most of our order growth comes from two businesses, outsourcing and our federal business.

Many of the larger federal procurements were pushed out of the first half of the year because of how the appropriations went in the federal government.

If you remember, the Department of Defense got pushed out month after month in the first half of the year.

It affected most major federal businesses.

And we all expect those still to be awarded but in the second half.

Even EAGLE itself was expected much earlier in the year and got pushed out.

So in both outsourcing and in federal we expect to return to those same growth rates in Q3 and Q4.

We consider Q2 to be an anomaly.

Okay, thanks.

I know the federal business has generally been a very strong area for you and clearly there were government spending issues that impacted everyone.

What about some of the other verticals though, financial services in particular?

Remember our largest orders don't come out of the systems integration business, occasionally they do.

They primarily come out of the outsourcing business.

I think you are going to see a fairly broad approach across all industries.

So there is no industry in particular that will be more successful than others in the second half.

I think you'll see us be successful across all our major segments in the outsourcing segment.

Okay, and just one more question on the technology business.

Given the new models that were introduced in the second quarter, how are you looking at the second half growth?

Should we see another strong pickup in the fourth quarter or do you think that customers are more likely to wait for the pure Intel-based models in 2008?

Yes, that is a good question.

Let me put it in even a broader context.

The way we look at it is from multiple dimensions.

The first is short-term impact because there is going to be a 40% overall performance improvement on both sides of the ClearPath family, MCP and OS2200, we believe that there will be -- and we believe there is pent-up demand.

Remember we have a fairly structured base, about 2000 clients around the world.

And they have pretty good visibility into our roadmaps.

And so for both sides of the family, both sides have performance improvements in new models and the second half.

We don't believe those customers will wait.

We think the new architecture was more about long-term viability of this family.

Remember, in the CMOS segment of this business because of the performance requirements at the very high end, people are questioning CMOS chips vis-à-vis standard Intel as the way to go.

So for that, it is really comfort in our long-term strategy.

Some people will experiment with that in 2007.

I think you'll see most of that growth in the new architecture occur in 2008 for us.

That is why you won't see a major second-half impact in that business.

So short-term it is the upgrades to -- and remember these are CMOS upgrades to the ClearPath family second half.

Long-term it is comfort about, hey, this is an all Intel, both x86 and Itanium strategy.

We're actually the only major supplier that offers both that allows us to hedge our bets across both sides of Intel's semiconductor architecture.

That very comforting.

The NEC piece that allows us to reduce our overall R&D and be codependent with NEC in this is actually very important.

You may have seen the recent NEC announcement in this area, may have seen recent Intel announcements in this area about the next generation Dual-Core chipsets for both x86 and Itanium.

And we want to leverage their investments as opposed to ours.

Here is what it also allows us to do.

It allows us to lower our fixed costs.

So you know that we had a target for $50 million reduction in R&D overall as a company.

We've increased that to 60 as part of these recent announcements.

We also lowered our SG&A overall as part of both G&A and direct sales.

And we've taken manufacturing from a fixed cost to a durable cost by moving that to NEC.

So overall, the combination of short-term decisions, longer-term decision about comfort about this overall architecture, and cost reduction gives us much greater comfort in that overall portfolio.

Just a quick follow-up and then I will turn it over.

On that point about technology, I was surprised to see the technology operating margin fall as much as they did just sequentially and year-over-year.

And I understand you have a lot of these initiatives underway that should help that in terms of lowering the fixed cost base, reducing R&D and so on.

What is the right margin that we should be looking for on this business especially as it moves from a proprietary platform to an Intel-based platform?

We expect both segments to move to that target margin that we have for 2008 which is 8% to 10% excluding pension.

And so we expect both of them to be able to stand up on their own inside that operating margin range in the 2008 timeframe.

Thank you.

Great.

One other thing, and I misspoke a bit earlier and I took a note to myself.

I mentioned 150 reductions in Europe, the real number was 750.

So please make that correction.

Jason Kupferberg with UBS.

Hey, guys.

I wanted to ask a couple of questions on the projected cost savings here.

You've increased the number here for second half '07 to $325 million with a plus sign next to it.

And I guess I wanted to get a sense of how much greater than 325 could that number be?

And to the extent that it is higher than 325, what would potentially be the drivers there?

Jason, we deliberately hedged that number knowing that you would come back with this question.

The answer is, remember even though the number, our total number, remember our original number we went out with was 3600, we came back with 5500.

Even though the total number is 50% greater, we thought it was equally important to achieve other objectives like accelerating global sourcing.

And so when you see us actually reuse some of that savings, it is because of other strategic alternatives, meaning that we really believe that we were somewhat behind our competitors in the use of global sourcing.

Even though I just mentioned that we ran out of capacity in our first Bangalore site, we are still behind many of our largest competitors.

So building out and fully staffing the second Bangalore site is a priority.

A second city in India is a priority, getting to the right capacity level in China is a priority as is central eastern Europe.

So the reason we've hedged on the 325 number is that what we are trying to do is wisely use some of those savings to close other gaps versus our competitors in some of these strategic areas.

And so you won't see me go higher than the plus number.

But I will help you a bit in showing how it parcels out.

If you remember with the 250 number, delivery was 125, R&D was 50 and G&A was 75.

In the 325 number, delivery has climbed to 165, an increase of 40.

R&D has climbed to 60, an increase of 10 and G&A has increased from 75 to 100, an increase of 25.

We've also accelerated the schedule.

If you've heard both Janet and I say that we will be 90% complete by year end and that is even with the new number which is actually an important additional element here.

One last thing I think is very important, we had originally pushed out the R&D number and it was calendarized out through 2007 based on the original roadmap we had codesigned with NEC.

Because of some positive things that have occurred with Intel accelerating chip deliveries and our work with NEC accelerating, we've been able to take those costs out faster because of the substitution capability of Intel and because of how well the NEC relationship is working.

So I won't answer your question about 325 plus.

I will give you the broader general answer about the reinvestment part of it which is important to us.

It is not these aren't nice to have investments -- these are need to have investments in terms of our competitiveness in the marketplace.

Okay, the reinvestments make a lot of sense.

And just a clarification along those lines, you kind of went out of the way in the press release to say that the 325 plus is net of investments.

I don't recall seeing that language prior.

Was the prior 250 plus number also net of reinvestments?

I'm just trying to get a sense on an apples-to-apples basis, are we increasing the number by 75 million or is it even more than 75 million?

Sorry, Jason, it's a great question.

We needed all of that to flow to the bottom line in the first restructuring decision.

And when we were able to go further, it became of equally critical importance for us to redeploy those savings into global sourcing.

So in the first phase we needed to accomplish that and wanted to drive most of that to the bottom line.

In the second we can afford to be more aggressive in driving this global sourcing because forward-looking that makes us much more competitive from a pricing standpoint.

We had a gap from a pricing standpoint versus many of our competitors.

This puts us in a much more competitive position which actually can impact things immediately in things that we price as soon as these actions take place.

Jason, this is Janet.

I just want to comment on that.

The 250 plus that we used in the first quarter, the plus came from the potential impact for the continental European actions which we said that we were going to do when we did the first-quarter earnings release.

But we did not take a charge in the first quarter period.

So the 250 plus that we talked about in the first-quarter earnings call included the continental European actions that are in the second-quarter charge.

Okay, okay, that is helpful.

Given that we can recognize that the cost savings here are moving more aggressively than originally planned -- I think it is north of 500 bps of margin expansion potentially in our model once -- the cost savings come during the second half of next year.

Given that though, are you guys still kind of in parallel with this considering other potential strategic alternatives for the Company?

Or any comments you can make along those lines also as it may tie into the divestiture program that you've discussed in the past.

Thanks.

No comments on the first part of your question.

On the second part of your question, divestitures, we are pretty far along in a number of different businesses that did not meet the profile that we thought was required to be part of this transformed business.

So we are pretty far along in due diligence phase there but that said, because of how successful we were in the proceeds from the NEC divestiture we are trying to ensure we get the right price.

And so it is hard for us to accurately outlook because we won't compromise in terms of what we are doing here although we've made a lot of progress.

So is it possible in the second half?

Absolutely.

We are not making any commitments at this point.

The divestiture, the NUL divestiture that we did --

Yes, sorry.

Right.

Of course.

Just a last question if I can sneak in one on CapEx, Janet, building on some of your comments.

In absolute dollars the CapEx was down pretty significantly and showing some improvement there.

Is this trend kind of sustainable?

I think you also had CapEx down year-over-year last quarter, maybe not to the same extent.

But as we kind of think about the free cash flow profile of the Company especially post headcount cuts, how are you guys thinking about CapEx as a percentage of revenues?

Yes, Jason, we have put a very specific focus on reducing the CapEx particularly in the structure of our outsourcing deals.

We did comment that in the BPO deal that we are pursuing going forward that we don't expect them to be as capital intensive as our prior BPO deal.

So you would expect to see the outsourcing trend to continue as a decline in the number and the amount of investments that we are making in outsourcing.

So that absolutely is a fundamental shift for us compared to the historical pattern of looking at our capital expenditures and outsourcing comparison to deals.

I should also comment though, as I mentioned in the call, we have tried to structure -- when we review deals, particularly the multi-year outsourcing deals, we are looking not just at the revenue and the profit we are also looking at the cash flow component of that.

You will see a corresponding decrease in the amount of customer deposits and prepayments offsetting that CapEx decline in outsourcing.

But we have changed the business model going forward.

Okay.

Thanks guys.

We are running a little short on time so I'd like people to just ask one question if they could.

Thank you.

Ashwin Shirvaikar with Citigroup.

Hi.

Thanks for taking my question.

Joe, as you put in cost reduction initiatives and become more competitive, should we not expect higher orders and sort of lower -- excluding not to belabor the point -- but excluding federal moving out, what was the profile of orders that you saw?

Yes, Ashwin, thanks.

The profile in this quarter wasn't terribly different.

But what we found is we didn't lose any significant number of orders in this quarter but quite a number of them moved out Q2 to Q3.

And so the reason I showed such confidence in Julie's earlier question about it is we didn't lose the competition.

In fact a lot of the business is moving into our sweet spot.

Remember we were disadvantaged in the megadeal space which is kind of the billion dollar plus deal.

You probably read from TPI and others that the average deal size is getting smaller and it is in the 50 to 100 range.

That actually advantages us as larger deals get broken down into smaller deals and they are broken down into the various outsourcing subsegments.

So we don't find ourselves disadvantaged but we did find that these things drifted out of the quarter but we expect to recover them in the second half of the year.

So we don't think we really lost any of them.

That said, we were not competitively advantaged from a price standpoint in the first half until we get these people out.

And you've seen a lot of progress but there is still work to be done.

You saw the numbers for the third and fourth quarter.

And until we get a sufficient critical mass in all of our global resourcing sites, we will still be somewhat competitively disadvantaged from a pricing standpoint.

That said, we can forward price and take advantage of the known movement of these resources since these people are scheduled to exit our Company and we are ramping in those other locations.

Okay, and one for Janet if I may.

Why does pension expense change to pension income in future years?

Is that a change in assumptions or is that just normal flowthrough from your actions?

Ashwin, it's coming from two reasons.

First let me comment that that is just the U.S. defined benefit plan.

So as a result of stopping the benefits in the plan, we no longer have what is referred to in the pension accounting the normal cost or the t expense related to our employee population earning new benefits.

So when that moves out, the reason we turn back to income is that we have the impact of all the actuarial assumptions up or down amortizing in and for us based upon where we are at now, having absorbed the actuarial losses from the core market performance in the earlier years, it just turns around to being an income coming in from that.

Okay.

And just as a comment I kind of find it odd that you stopped providing pension disclosure when it changes to income from expense.

Is there any way I can convince you to keep providing --?

Ashwin, as the number has become less variable from quarter to quarter, we just believe that it wasn't appropriate to break -- go all the way to do the income statement without the pension expense.

We have during the course of our commentary today provided you with all the elements to enable you to show the information with and without the pension expense.

But we just believe that given the narrowing of the range and the fact that it has got predictability going forward, we just believe that it was an appropriate time to switch off of that non-GAAP presentation.

But we will continue to provide all the appropriate information to allow you to be able to look at the results with and without it.

Okay, thanks. (multiple speakers)

Operator, I think we have time for one more.

Gregg Smith with Merrill Lynch.

Just the extra 1900 people on the headcount reduction side, just wondering why was that not in the original plan and what really changed -- caused those additional reductions?

Was it further kind of weakness in the business or just the realization that you needed additional cost cuts to hit those future margin targets?

What was really the impetus for that?

No.

If -- you've done headcount reductions in Europe as an illustration.

What you realize is it is a fairly sophisticated process of working with both what is called your work or workers councils, their union representatives and so on.

So it is a pretty elongated process.

So we really were looking for the second piece to cover that.

Remember they also cost more.

In our first piece of restructuring, there is pretty aggressive payback periods; in the second piece of restructuring, these are much longer payback periods for the Europeans and so on.

And it takes a lot longer.

And so in order for us to take the appropriate actions, we have to make sure that we honor all the right accounting principles in booking those and be able to frankly name names and inform the individuals.

Okay?

That actually even affects our second half of what is in Q3 and what is in Q4.

Right -- that process.

That said the increase wasn't due to needing to increase it vis-à-vis additional softness.

Our real focus here was about global sourcing.

Our first focus was we needed to get our costs in line.

Our second was to be able to get more competitively at a parity position in global sourcing.

This has taken quite a number of important steps in accomplishing that.

That is why you don't see the same type of savings pass-through on it.

Okay.

And then just quickly if I can.

Can we get an update on iPSL?

Is that still projected to break even and how about the other problem, BPO contract?

Yes, in terms of iPSL, it is essentially breakeven.

In the other if you remember in the past, we've talked about it is really two major clients in it and the first we've gotten them to breakeven.

The second it has been a tough but successful continuous improvement.

We are not home yet.

It may take us to year end to accomplish that.

Okay, great.

Thank you.

Thank you.

In summary there are three major things we wanted to communicate today.

One is frankly we are excited about the ability to increase the overall targeted cost reduction by 50%.

We are also excited that we have been able to accelerate the overall timeframe.

And the second part of that is we are excited that we have been able to use some of those proceeds to aggressively gain further momentum in our global sourcing program.

So we find that extremely important.

Last on the technology piece, because of the softness in the first half, we are extremely excited.

We didn't make this announcement until the very end of June, but we believe in laying out this next three-year plan you are going to see a real positive impact overall in our technology business.

Julie, one clarification and that is when we announced our traditional CMOS machines the second half of the year it is the high end of the ClearPath family.

What we are announcing on the Intel family next year is the low end of the Intel family.

And what we are announcing in 2008 is the high end of the Intel family.

So the people that are buying this year couldn't find the next generation architecture to meet their needs until 2008 anyway and in some cases 2009.

So we believe the calendarization of this won't cannibalize the most recent introduction and we think it is timed appropriately.

So as I said, despite a mixed operating result quarter, we are excited about the real progress we've made from a cost reduction perspective.

Thank you very much.

And that concludes today's teleconference.

Thank you for your participation and have a great day.