Unisys Corp (UIS) 2007 Q2 法說會逐字稿

Good day, everyone and welcome to this Unisys second quarter 2007 earnings results conference call.

At this time, for opening remarks and introductions I'd like to turn the call over to Mr.

Jack McHale, Vice President of Investor Relations at Unisys Corporation.

Mr.

McHale, please go ahead, sir.

Well, thank you, Operator.

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

Earlier this morning, Unisys released its second quarter 2007 financial results, and with us this morning to discuss these 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 the 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.

Call participants are in a listen-only mode until the Q & A session.

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

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 retirement expense and restructuring charges.

In the presentation, we have provided a reconciliation of our reported results on a U.S.

GAAP basis compared with our results excluding the impact of restructuring charges and retirement expense.

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 reports as filed with the SEC.

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

Now, let me turn the call over to Joe.

Thank you.

Thanks, Jack.

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

To begin our discussion this morning, please turn to Slide One.

This was a solid quarter for Unisys as we continued to enhance our profitability and reposition the Company in the marketplace.

As most of you know, we are about halfway into a three year program to drive toward an 8 to 10% operating profit margin excluding retirement expense in 2008.

We made continued good progress toward that goal in the quarter.

As you'll see in a moment, excluding restructuring charges and retirement expense, we improved our operating profit by $48 million, and drove to a 3.7% profit margin in the quarter.

We also saw significantly improved cash flow from operations.

Importantly, we continue to lay the foundation for future revenue growth.

We saw strong double digit growth in our services orders in the quarter.

We have a great deal of work yet do as we drive toward our 2008 financial goals but we're making steady progress.

We're focused on continuing to execute the repositioning program in the second half of this year.

This morning, I will update you on where we stand with key elements of the repositioning, but before I begin, let's take a look at the financial results in the quarter.

Please turn to Slide Two for an overview of the results.

At the top line, revenue declined 2% in the quarter.

Services revenue declined 1% in the quarter.

We saw continued good revenue growth in outsourcing, which was offset by our weakness in our systems integration and consulting business.

Our SI and consulting business has been impacted by disruptions from our repositioning program, but we did see strong orders in this business, as I'll discuss in a moment.

Technology revenue declined 9% in the quarter, driven primarily by a continued secular decline in mainframe revenue.

Turning to the bottom line.

Please note that our GAAP results in the quarter include a $24 million net restructuring charge, as well as $25 million in retirement-related expense.

On a non-GAAP basis, excluding restructuring charges and retirement-related expense, we reported operating profit of $51 million in the quarter.

This was a year-over-year improvement of $48 million.

Slide three shows how our overall operating profit margins have progressed over the past six quarters as we have implemented our repositioning program.

This is on a GAAP basis.

To see our operating margin progress on a non-GAAP basis, excluding restructuring charges and retirement-related expense, please turn to Slide Four.

As you can see on this slide, we're making continued progress toward that 2008 profit goal.

In the second half of 2007, we improved our non-GAAP operating profit margin to 3.7%, which is a 350 basis point improvement over the year ago quarter.

In our services business, which represents over 85% of our revenue, we improved our non-GAAP operating profit margin to 4.4% in the quarter, up 220 basis points year-over-year.

We look to continue the year-over-year improvement in our operating margin as we move through the second half of 2007.

You may recall back in April, I discussed that our operating profit last year was impacted, sorry, last quarter, was impacted by two issues: Lower volume in our systems integration and consulting business, and higher temporary labor contract costs.

As expected, these two issues continued to impact us in the second quarter.

Please turn to Slide Five for an update on these issues.

By way of background, in the area of temporary contract labor, our use of third party labor has increased this year to help maintain our service delivery levels during the transitional period as we implement headcount reductions.

We're taking actions to correct the situation and we expect to see improvements as we move through the second half of this year.

Regarding our systems integration and consulting business, as I mentioned earlier, this business has been the most impacted by the changes that we've made through our repositioning program.

It was in this business, for example, that we had the highest level of fragmentation prior to the repositioning, with dozens of small isolated programs and practices that did not meet our financial thresholds.

We continue to rationalize these programs as we focus on building out the practices in our broader based strategic growth areas.

We continue to look for improved results in our SI and consulting business in the second half of 2007.

As a positive sign, our SI and consulting orders showed substantial gains in the quarter.

We closed some significant SI and consulting orders during the quarter, including a breakthrough new contract with the U.S.

Federal Reserve Bank, and a recompete of our LA Leader contract in California.

These orders will also help this business in the second half.

On the subject of orders, please turn to Slide Six for an overview of demand trends that we're seeing in this business.

While we work on enhancing our bottom line profitability, we also continue to lay the foundation for future revenue growth.

We're doing this by continuing to build our strategic growth programs and expanding our pipeline of opportunities with our targeted large top 500 organizations around the world.

We are seeing positive trends as we drive this effort.

As I mentioned, our services orders showed strong double digit growth in the quarter.

Importantly, this order growth was broad based, cutting across most service lines and geographies.

In terms of service lines, orders grew in all lines except for core maintenance, which as you know is in secular decline.

From a geographic perspective, our orders in the quarter grew double digits in every geographic region except Latin America.

The strongest order gains were in Asia Pacific, Europe, and the United States.

In our client facing activities, we continued to focus on winning opportunities with targeted large top 500 organizations, given their size and IT budget.

During the quarter, we won a number of significant contracts with these Top 500 organizations, both new business and renewals.

You can see some with the second quarter orders on Slide Seven.

As I mentioned earlier, we closed two very sizeable systems integration and consulting contracts during the quarter.

We won a significant contract to design a high volume electronic check image processing exchange system, using open source technology for the U.S.

Federal Reserve Banks.

We also closed a four year contract extension, valued at about $108 million to continue providing public assistance programs for the Los Angeles Leader Program.

I had mentioned that we were working these in our last call in April.

In another large win, the City of Chicago awarded us a six year contract extension valued at $72 million, under which Unisys will expand the IT outsourcing services we provide to the City.

Unisys has been providing outsourcing service to the City's departments and citizens since 1999.

New services that we will provide under this extension include support of the City's Sun server infrastructures and Microsoft software.

Overseas, the European Commission awarded a Unisys-led consortium a five year framework contract to provide IT operations and support services for the Commission's Taxation and Customs Union Directorate General.

Under this contract, a client can order a maximum of approximately $100 million in IT services from the Consortium.

About 39% of the order value is expected to come to Unisys.

This is the third major IT services project awarded to Unisys by the European Commission over the past year.

In our U.S.

Federal business, we won a contract from the U.S.

Department of Defense to continue our work in operating and maintaining a leading edge system using RFID technology to track military supplies globally.

This is one of the world's largest implementations of radio frequency technology.

Unisys has been working on the security program for 13 years and we're pleased to continue with the project.

The contract term has been one base year worth $28 million and could be worth $112 million if the government exercises all option years.

Once again, you'll notice as we review this highlight list of wins that they cut across most of the strategic growth areas that we're focusing on in our sales and marketing activities, such as outsourcing, enterprise security, open source, and Microsoft solutions.

We are having good success in growing these programs.

As we do so, we continue to see a mix change occurring in our revenue model.

Turning to slide eight, last quarter I showed you this slide to depict what's happening within our business mix, as we shift our focus to our growth programs.

Revenue from our strategic programs represented about 50% of our revenue in 2006.

We estimate the total revenue from these programs grew about 10% in the second quarter, the highest growth was in enterprise security and open source.

At the same time that we grow in these higher value-added areas, we see declining revenue from our lower value areas in the business that we are deemphasizing, as well as other areas that are declining secularly such as ClearPath and Core Maintenance.

As this mix shift occurs, we continue to look for revenue from our strategic growth areas to grow to about 70% of our total revenue in 2008.

While we have much work to do in transforming our business mix and driving profitable growth, I am encouraged by the results we're beginning to see from our sales and marketing activities.

Additionally in our technology business, we added high level leadership talent in the quarter.

We were fortunate to recruit Rich [Varcello], former Senior Vice President and General Manager of Business Critical Servers at Hewlett Packard.

As President of Unisys' Systems and Technology business.

Rich replaces Leo [Diuoto], who is retiring from Unisys after a distinguished 39 year career with our Company.

Rich is a highly experienced dynamic business leader, who I believe will make great contributions to our technology business and to the Company overall.

He is currently evaluating new opportunities in the marketplace around realtime infrastructure, virtualization and security with the goal of driving future revenue growth in our technology business.

Moving on, please turn to slide nine for an update of our cost reduction and restructuring activities.

Across the Company, we continue to look for opportunities to further streamline our operation and reduce costs in line with our more focused business model.

During the second quarter, we implemented the first phase of a global effort to consolidate facility space and reduce lease expense.

This is an opportunity for the Company given the headcount reductions we've made over the past year, and also, our continued shift to a services-led mobile workforce where we have less need for fixed office space.

Janet will give you more details on this program.

Meanwhile, we continue to drive other aspects of the cost reduction program.

Based on our continuing process and productivity improvement activities, we took actions during the second quarter to further reduce our headcount by about 550 positions, primarily in the United States.

Including these reductions, we have announced a total of more than 7,100 headcount reductions since we launched the repositioning at the end of 2005.

During the second quarter, we completed about another 550 reductions, so we have completed about 80% of our announced reductions.

So while we are not done, the clear bulk of the restructuring is behind us.

This has not been an easy process, but it is critical for us to build a cost structure that reflects and supports our new business model and we are committed to getting there.

As we move into the second half of our repositioning, our emphasis is stepping up more to driving revenue growth.

As we do that, we are stepping up investments in our strategic growth programs.

In fact, we expect to reinvest essentially all of the savings from our new headcount reduction actions into growth programs and global sourcing.

So on a net basis, including our 2006 and first half 2007 restructuring activities, we continue to look for net annualized cost savings on a run rate basis of more than $340 million by the second half of 2007 and more than $365 million by the first half of 2008.

Turning to slide ten.

To summarize this morning, we made solid progress in the second quarter of 2007 in driving our repositioning program.

Our profitability and operating margins continued to improve.

We saw strong services order growth that was broad-based across service lines and geographies.

Our business mix is shifting toward the growing areas of the market, and as this happens, we are positioning ourselves for revenue growth down the road.

We have a lot of work yet to do as we drive toward our 2008 financial goals.

We have challenges, and as I've said before, our progress won't go in a straight line.

In particular, we are working through a couple issues in our Systems Integration business and around temporary contract labor, but we are making progress and we are confident that we are on the right track to achieve our 2008 goals.

Now, I'll turn the call over to Janet for a discussion of our second quarter financials.

Janet?

Thank you, Joe, and hello, everyone.

This morning, I would like to provide more details on our second quarter 2007 financial results.

I will explain the impact of restructuring charges, retirement-related expenses, and the significant change in the year-over-year tax provision.

To begin, please turn to Slide 11.

At the top line, we reported revenue of $1.38 billion for the second quarter of 2007.

This was down 2% from the year ago quarter, and currency had a three percentage point positive impact on our revenue in the quarter.

Our results for the second quarter of 2007, including net pre-tax restructuring charge of $24 million related to facility consolidations and headcount reduction.

A year ago, the second quarter included a net pre-tax restructuring charge of $141 million.

The second quarter 2007 results include $25 million of pre- tax retirement-related expense compared with $45 million a year ago.

Retirement related expense includes the expense for the Company's defined benefit pension plans and the U.S.

401(k) plan.

The tax provision also significantly changed from the year ago quarter.

The second quarter 2007 results include a $40.6 million of tax expense compared to a tax benefit in the second quarter of 2006.

As you know, the Company's provision or benefit for taxes will vary significantly quarter to quarter depending on the geographic distribution of income.

In the second quarter of 2007, we saw increased income in certain international jurisdictions where we still provide for taxes.

This increased income was due in large part to the profit improvement coming from our repositioning actions.

We reported a second quarter 2007 GAAP net loss of $65.5 million or $0.19 per share.

By comparison, in the year ago quarter, we reported a GAAP net loss of $194.6 million or $0.57 per share.

As Jack mentioned, please note at the end of these presentation slides, we've provided supplemental slides showing details on the restructuring charges and the retirement-related expense for the second quarters of 2007 and 2006.

Now, turning to revenue, please turn to slide 12 for an overview of our second quarter revenue by geography.

Our U.S.

Revenue represented 43% of our revenue in the quarter and declined 7% in the second quarter.

The decline was principally driven by continued weakness in systems integration and consulting.

As Joe mentioned, however, we did see substantial order growth in our U.S.

and Systems Integration businesses this quarter.

International revenue grew 2% in the quarter.

We saw growth in Pacific Asia and Europe, partially offset by a revenue decline in Japan and Brazil.

International revenue accounted for 57% of our revenue in the second quarter.

Moving to Slide 13 to see our revenue by business segment.

Services revenue declined 1%, and represented 88% of our second quarter revenue.

Our technology revenue declined 9% and represented 12% of our revenue in the quarter.

Moving on to more detail in our services revenue, please turn to Slide 14.

Within services, we saw 7% revenue growth in outsourcing.

This was offset by an 8% revenue decline in our Systems Integration and Consulting revenue.

We also saw a slight revenue decline in infrastructure services and the continued secular decline in our core maintenance revenue.

Turning to Slide 15 in our Technology business, revenue from Enterprise Servers declined 12% in the quarter and represented 76% of our Technology revenue in the quarter.

Within Enterprise Servers, revenue from ClearPath systems was down 10% in the quarter, as expected.

We anticipate that second half ClearPath revenue will sequentially improve over the first half and as we have seen previously, it is hard to call the second half ClearPath revenue between the third and fourth quarters.

Right now, the second half seems more skewed to the fourth quarter than last year.

Moving to Expenses.

We continue to drive our plan to reduce operating expenses across the Company.

This effort involves reengineering processes and identifying opportunities to streamline our operations.

Benchmarking is key to this effort, from general and Administrative cost to our internal use of IT, to our facilities cost, we have benchmarked key areas of the Company against best-in-class organization and competitors, and we have set targets for where we need to get to in order to make ourselves a best-in-class operation.

This kind of in-depth benchmarking analysis helped us implement our headcount reductions over the past year.

As Joe mentioned, we are also in the process of evaluating our need for facility space globally, given our streamline business model and our continued evolution to a services led model.

We took the first step in that process in the second quarter by consolidating lease space around the world.

We are currently looking at other potential opportunities and hope to take additional actions later in the year to further consolidate facility space.

Our efforts to reduce operating expenses are yielding good results.

Slide 16 shows our operating expenses through 2006 and the first two quarters of 2007.

This is on a GAAP basis.

Operating expenses include both selling, general, and administrative expense and research and development expense.

Slide 17 shows our operating expenses over this period, excluding restructuring charges and retirement-related expense.

As you can see on this non-GAAP basis, operating expenses declined from 22% of revenue in the first quarter of 2006 to 19.2% of revenue in the current quarter.

Now, moving on to segment margins, you may remember that Unisys has a longstanding policy to evaluate business segment performance on operating income, exclusive of restructuring charges.

Therefore, my comments on Segment Performance exclude the second quarter 2007 and 2006 restructuring charges that i have earlier discussed.

As we focus on streamlining our operations, increasing our use of lower cost offshore resources, and shifting towards higher value-added services, we are are seeing benefits in our business segment margin.

Slide 18 shows margins for our Services and Technology segments in the second quarter.

This is on a GAAP basis, including retirement-related expenses.

On a non-GAAP basis, services gross margins improved 190 basis points and services operating margins improved 220 basis points to 4.4% from 2.2% a year ago.

This is particularly significant, given that services now represent over 85% of our total revenue.

Technology gross and operating margins also substantially improved in the quarter from a year ago.

We have a great deal more work to do to further enhance our segment margins as we drive towards our 2008 corporate financial targets, but we are making good progress.

Now, please turn to Slide 19 for an overview of cash flow in the second quarter of 2007.

We saw improvement in our operating cash flow in the quarter.

We generated $23 million of cash from operations in the quarter.

In the year ago quarter, we used $193 million of cash flow from operations.

The improvement in operational cash flow reflected improved profitability, improved working capital performance, and the receipt of the expected foreign income tax refund that we talked about in the first quarter.

In the quarter, we used approximately $37 million of cash for restructuring payments, compared to $34 million in the second quarter of 2006.

Total capital expenditures in the second quarter of 2007 were $84 million compared with $65 million a year ago.

The increase reflects higher expenditures on outsourcing projects, particularly as we began three new client projects.

After deducting Capital Expenditures, we used $61 million of free cash in the second quarter of 2007 compared to a free cash usage of $258 million in the year ago quarter.

Depreciation and amortization was $91 million in the second quarter of 2007 and the Company ended the quarter with a cash balance of $521 million.

Looking ahead for full year 2007, we anticipate Capital Expenditures of around $300 million and depreciation and amortization in the $360 million to $375 million range.

In terms of the repositioning program, we expect to use a total of approximately $160 million of cash for restructuring programs in 2007, for the charges taken through the second quarter of 2007.

In closing, we made continued progress in our repositioning programs in the second quarter.

We are showing good execution and discipline in implementing our cost reduction initiatives, and we are seeing the results in our expenses and margins.

I was also pleased with our cash flow improvement in the quarter.

We are focused on continuing our progress in the second half of 2007.

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

Well, thank you, Janet, and thank you, Joe.

Operator?

We would now like to move to investor questions, please.

Yes.

([OPERATOR INSTRUCTIONS).

The first question will come from Jason Kupferberg with UBS.

Good morning, guys, and nice progress here on the margin front.

Wanted to ask a question on the subcontractor labor, and I mean in the context of the fact that the margins have improved nicely year-over-year, and we're seeing some acceleration which I think is a most important point.

Can you give us an idea of how much the elevated use of subcontractor labor is impacting your operating margins currently?

First of all, good morning, Jason, and thanks for the compliment.

On this whole contracted labor issue, let me just give you some background that I shared with you last time as well.

If you remember, we said that it was really going to take us some serious work around process redesign using Six Sigma people, and actually some system design, meaning IT system design in support of this change to really allow us to work through this on a continuous improvement basis in the second half.

I'm looking at Janet to see if we really shared numbers previously on what was the size of it?

No, we did say that as we built our plan to get to the 2008 goal, we did talk about the fact that we anticipated the savings to improve in the second half for the year versus the first half, so while the contractor expense is up compared to what we would have liked to have seen right now, we don't think that it's something that is detracting us from getting to our 2008 goal.

I think the other important issue here, Jason, is we've been very sensitive as we went through this, considering the largest part of all of our reductions in terms of this restructuring was in our services labor force, and so considering that between infrastructure and outsourcing, it's approximately 50% of our entire business, so we've worked very very carefully to make sure that none of these changes improve service levels for a combination of maintaining high customer satisfaction as well as there's penalties involved in not meeting them, so we've had a high degree of sensitivity both on the customer sat level, the service level agreements, and the financial implications of that to us as well, so if anything we've been a bit conservative in reengineering these people out of the business but we're convinced we can make it happen based on the programs we have under way.

Just to clarify there, in the second half of '07 you expect this extra expense to diminish relative to the first half?

Yes, we do, but you'll see it happen on a continuous improvement basis over the third and fourth quarter respectively.

Okay, and just to shift to the revenue line for a moment.

Do you expect to restore your year-over-year growth positive growth in the services business, revenues in the third quarter, obviously orders were up again nicely in Q2 and I would assume that some of the consulting and SI orders might convert to revenue a bit faster than some of the other types of orders?

Yeah, well you're on precisely the right issue.

The biggest weakness that we've had was in our systems integration consulting business as we shared with you, had the greatest amount of disruption around the repositioning, around rationalizing the solution set, refocusing them from like 4,000 clients to these Top 500 clients and so on, and we're starting to see the pay off from that.

You saw strong double digit revenue growth in Systems Integration in the second quarter and you're going to see that just as you outlooked, be able to turn to revenue faster than you might in a traditional outsourcing business.

The other positive thing here that we've seen is this growth back, this high order growth is in the strategic areas that we had them focused on, so we knew there was disruption as we move from these kind of fragmented older programs to the new, probably the best case study here happens to be the Federal Reserve deal which was essentially predominantly Open Source technology.

It's a very very high volume transaction processing.

If you remember, years ago people talked about Check 21 and Image Exchange instead of paper images, and this is a major strategic investment by the Fed Reserve and a major project for us here and it's a metaphor for this shift, so a lot of small projects, disruption, and now we're starting to see these larger very strategic projects come through at the other side, and you're right.

You'll start to see that in the third and fourth quarter respectively improving the performance of the SI business.

Do you expect services revenue growth overall though to be up in the third quarter year-over-year?

That would be me giving guidance and we're not giving guidance on third quarter, fourth quarter.

Okay.

Thanks.

Thanks.

(OPERATOR INSTRUCTIONS).

Moving on now to James Friedman with Susquehanna.

Hi, thanks.

Not to beat a dead horse about the subcontractor topic, but Janet, is there any way that you can help us quantify the magnitude of the use of subcontractors?

For example, could you give us an estimate of what it is as a percentage of revenue or if you keep it this way, what the difference between gross and net revenue might be?

Well, Jason, I'm sorry, James, let me just, when we talk about the contractors, we are talking about it relative to particular areas of the business, so it is not broad-based across the entire business.

It is primarily geared around customers where there are service level agreements in place and where we have engineering, we've taken headcount out and we still have some more efficiencies to be gained in implementing the systems, the track and support, the ongoing activities to customers, so it's more in the annuity-based business than it is in the shorter term systems integration business.

In that, so it's not broad based across the business.

We are continuing to work through the issue.

We don't think that it's anything that is outside of the norm.

We also do have some overlap as we've moved work offshore during the transition as well, and so we haven't, as a percentage of our overall spend in this area, the amount of subcontractor temporary labor that we use on a regular basis , it's up as a percentage of that, but it is a smaller portion of our overall business.

We haven't, I know other than giving you an absolute number, the only thing I can tell you is that we're not talking of something that's north of two or three points of

Okay.

The reason I ask is because it's not readily visible in your financial results because the gross margins are obviously improving.

That's right, that reinforces what I'm trying to say.

If we look at what we want to execute as a Company, we think the contractor spend is higher than what we want to have on an ongoing basis.

It is intentional to make sure we meet the customer service levels but as we said operationally a little bit higher than we would want.

It is not masking the improvement in the gross margins.

We're continuing to improve them.

This is one of the issues that caused us to say when we've taken the heads out that the savings would happen more in the second half of the year than the first half of the year, and we're just trying to identify that we've got in addition to the Systems Integration weakness in revenue, we have this other operational issue, that as we get through it, should yield further benefits as we move into the third and fourth quarter.

And James, I won't be any more specific there either but we do think it's important that we get it out by year-end.

We will always use some subcontractors as a business so it's not that we will completely eliminate it.

It helps us with the cyclicality parts of our business around the world.

But it is important for us to hit our final state, 8 to 10% operating profit in 2008, and it's important that we manage this carefully through the second half to insure it's out by year-end, at least the portion we've targeted.

Okay.

Switching gears for a second, some of your competitors had reported disruption in calendar second quarter with regard to the various challenges in the federal budgetary cycle.

Unless I missed it, you didn't speak about your federal operations explicitly.

Any observations or commentary there?

Federal or municipal?

Yeah.

Well, I'll stay with federal for you there for a second, but we see our revenue flattish over the course of this year, so we don't really see growth.

As you're probably aware, we look at our business in three major segments on there: Civilian, Homeland Security, and Defense.

We continue to see growth in our Civilian business, even though you would think based on some of the cost restraints they've tried to put in place, in Civilian, our teams have been creative and we've figured out how to price creatively and allow that business to grow, so Civilian has actually been a bright spot for us in terms of revenue growth.

I also know that the strong position we have in Department of Homeland Security and our ability to expand into various agencies and we see growth in that business as well in the second half of this year, but like many of our competitors, our biggest pressure on a downward basis is in defense.

It's because of the amount of money spent in the war effort and so that part of our business, although we've had some strategic wins like the recompete for this RFID project and a number of other ones downstream, that's the softest of our three businesses and why it ends up being flattish for us.

We're bullish on that business on a forward-looking basis because we're pursuing a pretty aggressive pipeline across all of the major agencies with a very high multi-billion dollar pipeline of opportunities, and pretty large deal sizes, so even though our expectations are modest for 2007, we have upbeat expectations for 2008 in the federal business.

Okay and then the last question, for Janet.

With regard to the account receivables securitization on Slide 19, could you just remind us about what sort of seasonality there is in that, if there's any and just the mechanics of how that works again?

Sure.

That Accounts Receivable securitization is in the U.S.

And so it has a tendency to move up and down depending upon the percentage of our revenue that comes from the United States.

In addition, that receivable securitization has a limit on the amount of receivables that are past due, so there's a calculation as we've disclosed in our financial statements about the amount of eligible receivables and how that's calculated, if it's based upon reviewing our past due and our problem accounts as part of the calculation, so we have that disclosed, that there is a limit on the amount of receivables we're allowed to sell in there, but the primary determinant of the fluctuation in that securitization facility is in fact the amount of business coming in from North America, and it generally is the acceleration of collections on our U.S.

receivables that have a normal 30 to 45 day payment term.

Thank you.

Thank you.

Now moving on we will take a question from Julie Santoriello with Morgan Stanley.

Thanks, good morning.

Good morning.

Hi, Joe.

Nice job on the margin improvement.

Very glad to see it.

A little disappointed about the services revenue not growing a bit faster.

I understand you're not going to give guidance for the full year.

I believe in the past you've spoken about a target for low single digit revenue growth for the year.

Does that still stand?

Julie you're talking about from an overall business perspective?

Yes, total.

And so we've said that as we've gone through the year, we were looking in a flat to low single digit type of outlook for the business that we have made that comment in the past while the systems integration revenue continues to be weak, we are encouraged by the order outlook and we've not changed our perspective on the top line, although the weakness in the systems integration could skew us to the lower end of that range.

Okay.

And can you talk generally about the sales strategy, the Sales and Marketing strategy now as sort of post-Peter Black more?

Have you seen any disruptions with his departure or do you expect any changes in strategy or turnover among the sales ranks?

It's a great question.

It turns out that most of the programs that Peter was a champion for, he and I had a shared vision about, whether it was Top 500 program or the revitalization of our sales organization, so we pretty much had a shared vision across all of those.

Our own teams asked if anything would change as soon as Peter left and nothing has really changed.

We're just as committed to the Top 500 program and we continue to accelerate a number of initiatives there, meaning we staff what we call the Top 50 of the blueprint accounts and we're actually staffing them stronger on a forward-looking basis than we have done and we've made the same level of committment around client business planning and those types of things and so I don't think you see any real changes.

Peter added a lot of value while he was here.

We wish him the best of luck with his new engagement, but the vast majority of the heavy lifting he did was already in place by the time he left.

So unfortunately we left and we'll miss him but there will be no changes there.

And Joe, do you think you would replace or put someone else in that role or do you think the sales management team at this point is more distributed, and also as a follow-up, are there other sort of high profile managerial positions that you've filled recently or are looking to fill?

As you might imagine, we can't answer the last part of this on a call like this, but the answer is what we really thought was the single most important thing we needed to do was to revitalize our technology business.

In Rich's case, he will probably be complimented if he's listening in on the call.

We've actually been pursuing him for some time.

It's probably close to a year because we thought he had the perfect insights of the kinds of things we wanted to do and when he was at Hewlett Packard, he was probably one of the most successful managers in moving really complicated programs like operating systems offshore to India.

Not to say we're going to move all of our operating systems there, but he's managed very large complex operations, and I hold him largely responsible for the resurgence at the high end of HP's business around Unix and Linux and their whole enterprise server group, so for us, although our introduction of this has been somewhat restrained, I think he's going to have a very positive impact on this business starting in the second half of the year and going forward, so that's probably our most significant change.

The other part of your question is would we replace Peter with someone in precisely that same job and the answer is no.

We've made changes around our Company and we believe we had sufficient talent to fill each of these roles that he was playing in the past.

Okay, and I'm sorry if I was unclear.

I was just curious if you were looking at recruiting some industry veteran types either in the Consulting Integration business or in the Outsourcing business to move up the ranks there.

Yes, without being specific there, we're like every other Company.

We're always looking to upgrade the talent that we have and what we found is despite being in this restructuring transformational effort, we've had very good success in continuing to recruit other talent, so for example, over this past year, we've recruited significant talent to begin the rebuilding of our systems and technology salesforce, and so this new Head of Worldwide Sales in that business who previously was SAP, new Head of North America in that business who was previously with Hewlett Packard and so on, so we've continued to recruit.

Some people would say surprisingly strong talent considering we're in the middle of a transformation and I think it's because people believe the story and are convinced that we're making the progress and will emerge on the other side a much much stronger competitor.

Thanks.

Just one more question for Janet on the CapEx spending.

Janet, can you explain to us a little bit further the nature of the investments there?

It sounds like it's related to three specific outsourcing contracts.

Wondering if these are just related to customer assets or if these are more akin to longer term investments or do you think you could make investments now and get leverage down the road?

No.

These are actual customer engagements.

They are in the outsourcing asset line on our statement of cash flows and on the balance sheet itself.

They relate to three specific new client wins that we've had that are in the start up phase, so you see a higher CapEx Spend in the first half of the year than we expect in the second half of the year, based upon my comment that we expect CapEx to come in around $300 million for the year but these are three new specific wins that have required capital to start those projects up.

Okay, thank you.

And now Ashwin Shirvaikar will have the next question from Citigroup.

Hello.

I keep coming back to this.

You keep announcing strong order growth and combine that with not just weak but declining revenue growth.

I'm wondering how much of this is perhaps due to heavily discounted contract extensions?

Yeah, Ashwin, this is Joe.

But you have to look at it in the greater context of the mix , so for example, if we have strong order growth in outsourcing, you've seen us have strong revenue growth in outsourcing, and so part of our challenge here is we have not had strong order growth in our systems integration consulting business and we paid the penalty for that for the three past consecutive quarters.

This is the first time we've seen a turnaround in order growth for the systems integration business, and although we don't give specific numbers, it's very aggressive double digit order growth, and so for all of our upside that you are seeing, you are seeing service line in outsourcing, remember we have secular decline in core maintenance, talking just core services, now, and we had a decline in systems integration as a result of weak order growth in System Integration so I think you'd expect to see the kinds of results that you saw in our

No, but Joe, here is the thing.

Your revenue growth in outsourcing is a full 500 basis points weaker than industry, in spite of what you claim for, and it's been December 2005 since you claimed strong order growth in revenue.

And if I take out the benefit of currency this quarter, you had minus 5% revenue growth.

It's been 18, 19, 20 months.

Ashwin, this is Janet.

Let me just make a couple of comments and then I'll turn it back over to Joe to talk about the business.

You are right that when you take a look at our order growth that that has not translated into revenue increases, in fact this quarter we've had a revenue decline.

If you go back during the time period, we've had the swing in the order growth happening from growth in orders, double digit growth in orders to declines in orders, in some cases double digit declines in orders.

Five of the last seven quarters we've had increases in orders but there are two quarters where we had declines in orders.

If you look at our year-end backlog at December, at the end of the year, that was in the single digit mid single digit increase in backlog, which is a better determinant as to what you're going to go forward.

The issue that we were having is as you look at that order comparison, we were building multi-year backlog deals and that the area of the business that we have been struggling with the weakness is the area that goes from order to revenue in the quickest time period within the services business, and that's the Systems Integration business, and with that business being weak at both the order line and that translating into the revenue line, it is really causing this distortion.

What we're trying to point out in the comments today is that we have seen significant improvement in the Systems Integration in the order side, with some of the wins that Joe talked about like the Federal Reserve this quarter.

Our challenge going forward is to translate that into the top line as -- to translate the orders into revenue as we go through and so yes we do have an anomaly right now where we have order growth that's not translating into revenue growth.

We have a couple quarters where we weren't going as you go past the seven quarters.

Our order growth is coming n multi-years and in some cases renewals like the LA County contract we talked about this quarter, but if you look alt our overall backlog, you see that the backlog grew in the mid single digits since the end of December.

We see a return to increase in Systems Integration this quarter which will hopefully translate into orders but we do have order growth fueling the annuity businesses.

Our short-term business that goes from orders to revenues quicker are the weaker areas of the business, and that is showing up and causing the revenue decline.

Now, from an overall perspective, we do point out, we talk about services orders and we don't talk about the overall orders because in the technology business as you know, that's primarily a sell and bill within the given quarter, so the comparison when we talk about orders is really services orders and it's compared against the total services revenue line and I'll turn it back to Joe.

But it would be nice if you guys gave real numbers that we could compare like all other companies do, but that does, Janet, thank you for the explanation.

It does bring me to my next question, if you have good order growth now in System Integration, why should I expect the use of contract labor to be transitional?

Because my earlier comment, I said that the increase in the contract labor was more in the annuity business, not in the Systems Integration business.

Okay.

Also, Ashwin, if you look, we've spent or invested an awful lot of effort and money in building the right base in India, China, and other countries to be able to support this business going forward, and some of that business is around people, some of that business is via contractors and we're not counting that in our other discussion, and so if you look at a lot of this new business, a fair amount of this business, because of what we do and how we separate architecture work from programming, using 3DVE, we can use a fair amount of what I'll call commoditized programming to India, and that's where we've made these big investments over the past years to get a sufficient critical mass both between ourselves and our partners in India to absorb that type of work of this increased revenue growth.

Let me also come back to your extensions, your comment about you'd have to make compromises in reducing margins on extensions.

That's not necessarily true.

If you look at a lot of these contracts, one of the reasons that LA Leader was postponed is we have increased margins on the renewal of that contract.

It became very controversial as you might imagine in the County increasing the revenue on that contract as we renewed it.

Same thing has been true in West Virginia and HIM, so we renew a contract and we've actually got increased margins.

That's not to say that sometimes they don't decrease, sure they do.

That's just the nature of the business, but we work just as hard on renewals to increase a combination of the scope of work and the margins going forward, so it's not what you might as interpreted as kind of empty renewals or renewals that we trade things off.

We have just as many that we actually enhance the type of work, the quality of work, and prospectively the margins for ourselves.

I was looking at the Chicago contract you announced today , used to be a five year, $75 million contract and now it's a six year, $72 million contract so that's just an example, but my last question, I don't want to take too much time here, but on cash flow, in the first six months of the year, you lost or you burned through close to a $0.25 billion of free cash.

Any thoughts on when that can turnaround or is this going to be, Janet, you did have a comment there

Right.

-- that second half was more skewed towards fourth quarter?

Well, no.

My comment on the second half was in the technology business, where I talked about the fact that we traditionally have a, in the ClearPath business, have a stronger second half than first half and my comment has been that as it's been previously, it's generally hard to call how those ClearPath transactions fall between the third and fourth quarter.

As we look at it right now, those transactions seem more skewed to the fourth quarter than last year, so that was my comment with regard to the skewing.

From a cash perspective, let's keep in mind that we do have restructuring payments that have been, that we've been making that are reflected in that cash from operations and we will continue our overall model that we are driving to in 2008 with the 8 to 10% operating profit.

Obviously, that should translate into significantly improved cash flow and this Management team equally worries about the top line, the bottom line, and cash flow in getting this business to what we believe is fully sustainable model going into 2008.

Okay, thank you.

I do wish you all the best going forward.

Thanks, Ashwin.

We will now take our final question from Julio Quinteros with Goldman Sachs.

Thank you.

Just wanted to check quickly, when you look at the impact of the SI consulting business specifically and you look at sort of the different things that are sort of happening in the shift to offshore, exposure to Public Services, do those pieces by themselves explain the weakness in SI consulting when I look across the space itself, we've seen pretty strong trends for some of the competitors, so it might be that there's something else going on beyond those issues, market share losses or anything along those lines that might provide a little bit more clarity on the SI consulting business.

Yes Julio, this is Joe.

I'll just give you a little more color, we keep talking about them and disruption, but remember as we went to the what we call the high performance centers or pooled delivery , that affected them more than anybody else.

80% of their resources are in these high performance centers and we moved 80% of their people over the course of this last 18 months or so.

We also, they are the focus of the majority of our training around new programs, so a traditional person in outsourcing if they are break fixed they don't get trained.

If you're a traditional call center person you don't get trained.

The people that we've made the biggest investments in training around Open Source, Microsoft, security are these same people.

The same thing is about portfolio rationalization.

We've gone from far too many small programs, often regional in nature, different ones for retail banking in Latin America, North America, Asia Pacific and so on to this much more concentrated core portfolio and a big change so if you're moving off the old program to the new, you're disrupted and then customers moving from 4,000 to 500, you're calling on these customers you're now calling on these customers.

The last piece is this group had the largest cost restructuring as a percentage of their population so to get them from where they were the traditional metric you'd measure an SI group is charge ability and rate realization to get them from their fairly low prior charge ability, there is a combination of pooling, retraining and a fair amount of restructuring and so it isn't until you're really done with all of those that there's enough stability that they can start working on these new efforts, so we would expect that.

Are they also affected a lot by offshore?

Sure they are.

We try to move an awful lot of what I will call the commoditized end of programming offshore, on the offshore front, we essentially believe we're on track as you know, we've targeted 20% of our population by the end of 08, total of 6,000 resources and we're about 3,300 as we speak, and we believe we're going to make our targets for this year, so that part is under way as well.

You mentioned public sector.

We have a slightly different strategy for public sector.

You can't move a lot of public sector work.

The Federal Government is most restrictive.

State and local somewhat less, but also restrictive, and we have a different strategy there called Low Cost Subsidiaries that's different salaries and different benefit plans and that is frankly behind our offshoring work, but you're going to see major movement from us in low cost subsidiaries in Q3 of this year and the second half of this year and that's primarily in support of both Federal Government work here and other major countries as well as State and local work and that is a second major initiative that allows us to get much more competitive in terms of our labor resources.

That's slightly behind for us, but we think we'll catch up in the second

Okay, and then are you adding heads to the SI consulting business currently?

The only place we're adding heads for their business with the exception of we need more subject matter experts in some of our high growth areas, security, Open Source and so on so we're hiring architects and subject matter experts, security gurus in those businesses but the majority of the programmers we're adding offshore.

Okay, and then finally, if you look at the expected cost savings and this has been one of the things I've been worried about over the course of the restructuring actions and the sort of benefits and the yield that you're expecting , at what point does the revenue declines that you guys are seeing in your business begin to comp or sort of reduce the yield of the cost savings expected, not only for the second half of '07 but also into next year.

In other words if revenue continues to decelerate at the current pace that we're seeing it decelerate, do you see a need to change the expected savings in the cost restructuring

Well, actually, we've seen some of that already, so if you looked at our systems integration decline, you'd see some impact on the current quarter.

As that business turns, you're going to see it go the other direction, all right?

Yes.

So you're going to start to see some of the positive impacts of the heavy lifting we put into the restructuring of that business in the second half.

You've seen some of the penalties of the impact of it in the second quarter.

Okay, great.

Thanks, guys.

Good luck.

Thanks.

It looks like that will conclude our question and answer session.

I'll turn the call back over to our host for closing remarks.

Great.

I want to thank all of you for staying close to us through this and your support and some of your tough questions.

We are very bullish about our business going forward in terms of if we can work through some of these remaining challenges and systems integration and in contractors, I think we can have a strong second half as Janet mentioned.

We see a very strong backended technology business in the second half, so we're cautiously optimistic on the balance of this year.

Thank you very much.

That will conclude your call for today.

We thank you for your participation and everyone have a wonderful day.