SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
__________________________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________.
Commission file number 1-8729
UNISYS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 38-0387840
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
Unisys Way
Blue Bell, Pennsylvania 19424
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 986-4011
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ]
Number of shares of Common Stock outstanding as of September 30, 2004:
335,930,924.
2
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements.
UNISYS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Millions)
Sept. 30,
2004 December 31,
(Unaudited) 2003
----------- ------------
Assets
- ------
Current assets
Cash and cash equivalents $573.7 $ 635.9
Accounts and notes receivable, net 962.0 1,027.8
Inventories
Parts and finished equipment 102.2 121.7
Work in process and materials 117.7 116.9
Deferred income taxes 295.0 270.0
Other current assets 104.9 85.7
-------- --------
Total 2,155.5 2,258.0
-------- --------
Properties 1,364.9 1,352.7
Less-Accumulated depreciation
and amortization 952.5 928.5
-------- --------
Properties, net 412.4 424.2
-------- --------
Outsourcing assets, net 510.9 477.5
Marketable software, net 341.3 332.2
Investments at equity 166.4 153.3
Prepaid pension cost 49.2 55.5
Deferred income taxes 1,385.7 1,384.6
Goodwill 185.3 177.5
Other long-term assets 203.5 211.8
-------- --------
Total $5,410.2 $5,474.6
======== ========
Liabilities and stockholders' equity
- ------------------------------------
Current liabilities
Notes payable $ 20.0 $ 17.7
Current maturities of long-term debt 150.8 2.2
Accounts payable 392.6 513.8
Other accrued liabilities 1,233.5 1,305.7
Income taxes payable 153.5 214.1
-------- --------
Total 1,950.4 2,053.5
-------- --------
Long-term debt 899.5 1,048.3
Accrued pension liabilities 471.6 433.6
Other long-term liabilities 551.1 544.0
Stockholders' equity
Common stock, shares issued: 2004, 337.9;
2003, 333.8 3.4 3.3
Accumulated deficit (341.3) ( 414.8)
Other capital 3,869.4 3,818.6
Accumulated other comprehensive loss (1,993.9) (2,011.9)
-------- --------
Stockholders' equity 1,537.6 1,395.2
-------- --------
Total $5,410.2 $5,474.6
======== ========
See notes to consolidated financial statements.
3
UNISYS CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Millions, except per share data)
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
2004 2003 2004 2003
-------- -------- -------- --------
Revenue
Services $1,147.1 $1,124.3 $3,470.9 $3,394.7
Technology 298.6 325.4 825.8 878.9
-------- -------- -------- --------
1,445.7 1,449.7 4,296.7 4,273.6
Costs and expenses
Cost of revenue:
Services 965.7 886.1 2,821.6 2,675.4
Technology 139.0 138.5 375.5 393.9
-------- -------- -------- --------
1,104.7 1,024.6 3,197.1 3,069.3
Selling, general and
administrative expenses 303.7 251.0 837.8 737.1
Research and development expenses 75.3 68.2 218.1 198.7
-------- -------- -------- --------
1,483.7 1,343.8 4,253.0 4,005.1
-------- -------- -------- --------
Operating income (loss) (38.0) 105.9 43.7 268.5
Interest expense 16.2 17.2 51.4 51.3
Other income (expense), net (3.0) (4.7) 21.6 2.5
-------- -------- -------- --------
Income (loss) before income taxes (57.2) 84.0 13.9 219.7
Provision (loss) for income taxes (82.4) 27.8 (59.6) 72.5
-------- -------- -------- --------
Net income $ 25.2 $ 56.2 $ 73.5 $ 147.2
======== ======== ======== ========
Earnings per share
Basic $ .08 $ .17 $ .22 $ .45
======== ======== ======== ========
Diluted $ .07 $ .17 $ .22 $ .44
======== ======== ======== ========
See notes to consolidated financial statements.
4
UNISYS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Millions)
Nine Months Ended
September 30
-----------------
2004 2003
-------- -------
Cash flows from operating activities
Net income $ 73.5 $ 147.2
Add(deduct) items to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization of properties and
outsourcing assets 181.7 154.9
Amortization of marketable software 96.6 92.2
(Increase) in deferred income taxes, net (25.3) ( 2.5)
Decrease (increase) in receivables, net 97.2 ( 32.3)
Decrease in inventories 19.1 43.0
(Decrease) in accounts payable and other
accrued liabilities (207.5) (192.8)
(Decrease) increase in income taxes payable (52.6) 19.8
Increase (decrease) in other liabilities 19.8 ( 44.0)
(Increase) in other assets (34.0) ( 29.9)
Other 44.7 6.5
------- ------
Net cash provided by operating activities 213.2 162.1
------- ------
Cash flows from investing activities
Proceeds from investments 4,423.4 3,626.1
Purchases of investments (4,427.4) (3,663.2)
Investment in marketable software (88.8) (109.4)
Capital additions of properties and
outsourcing assets (192.4) (177.9)
Purchases of businesses (18.6) ( 2.0)
------- ------
Net cash used for investing activities (303.8) (326.4)
------- ------
Cash flows from financing activities
Net reduction in short-term borrowings (1.0) ( 57.0)
Proceeds from employee stock plans 30.9 21.0
Payments of long-term debt ( 2.3) ( 3.8)
Proceeds from issuance of long-term debt - 293.3
------- ------
Net cash provided by financing activities 27.6 253.5
------- ------
Effect of exchange rate changes on
cash and cash equivalents .8 11.7
------- ------
Increase (decrease) in cash and cash equivalents (62.2) 100.9
Cash and cash equivalents, beginning of period 635.9 301.8
------- -------
Cash and cash equivalents, end of period $ 573.7 $ 402.7
======= =======
See notes to consolidated financial statements.
5
UNISYS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
In the opinion of management, the financial information furnished
herein reflects all adjustments necessary for a fair presentation of the
financial position, results of operations and cash flows for the interim
periods specified. These adjustments consist only of normal recurring
accruals except as disclosed herein. Because of seasonal and other factors,
results for interim periods are not necessarily indicative of the results to
be expected for the full year.
a. The following table shows how earnings per share were computed for the
three and nine months ended September 30, 2004 and 2003 (dollars in
millions, shares in thousands):
Three Months Ended Nine Months Ended
September 30 September 30
------------------ ------------------
2004 2003 2004 2003
------- ------- ------- -------
Basic Earnings Per Share
Net income $ 25.2 $ 56.2 $ 73.5 $ 147.2
======= ======= ======= =======
Weighted average shares 335,576 330,033 334,236 328,675
======= ======= ======= =======
Basic earnings per share $ .08 $ .17 $ .22 $ .45
======= ======= ======= =======
Diluted Earnings Per Share
Net income $ 25.2 $ 56.2 $ 73.5 $ 147.2
======== ======= ======= =======
Weighted average shares 335,576 330,033 334,236 328,675
Plus incremental shares
from assumed exercises
under employee stock plans 1,786 3,946 3,823 2,642
------- ------- ------- -------
Adjusted weighted average
shares 337,362 333,979 338,059 331,317
======= ======= ======= =======
Diluted earnings per share $ .07 $ .17 $ .22 $ .44
======= ======= ======= =======
At September 30, 2004, 35.9 million shares related to employee stock plans
were not included in the computation of diluted earnings per share because
the option prices are above the average market price of the company's common
stock.
b. As part of its ongoing efforts to reduce its cost base and enhance its
administrative efficiency, on September 30, 2004, the company consolidated
facility space and committed to a reduction of approximately 1,400
employees, primarily in general and administrative areas. These actions
resulted in a pretax charge of $82.0 million, or $.18 per diluted share.
The charge related to headcount reductions is approximately $75.3 million
and is broken down as follows: (a) approximately 750 employees in the U.S.
for a charge of about $23.2 million and (b) 650 employees outside the U.S.
for a charge of about $52.1 million. The charge for employee reductions is
principally related to severance costs. Other employee-related costs are
not significant. The facility charge of approximately $6.7 million relates
principally to a single U.S. leased property that as of September 30, 2004
the company ceased using. The facility charge represents the fair value of
the liability at the cease-use date and was determined based on the
remaining lease rental payments, reduced by estimated sublease rentals that
could be reasonably obtained for the property.
The employee reductions are expected to be substantially completed by the
end of the second quarter of 2005. The company estimates that the cash
requirements for the cost reduction actions will be about $85 million,
mostly in 2005. The company anticipates that these actions will yield
approximately $70 million of annualized cost savings on a run-rate basis by
the end of 2005, thereby making the company better able to compete in the
marketplace.
The pretax charge was recorded in the following statement of income
classifications: cost of revenue-services, $28.1 million; selling, general
and administrative expenses, $50.2 million; research and development
6
expenses, $8.4 million; and other income (expense), net, $4.7 million. The
income recorded in other income (expense), net relates to minority
shareholders' portion of the charge related to a 51% owned subsidiary which
is fully consolidated by the company.
c. During the September 2004 quarter, the U.S. Congressional Joint Committee on
Taxation approved an income tax refund to the company related to the
settlement of tax audit issues dating from the mid-1980s. The refund,
including interest, is approximately $40 million and is recorded in current
accounts receivable in the company's consolidated balance sheet. After
payment of related state taxes, the company expects a net cash refund of
approximately $30 million by the end of 2004 or in early 2005. As a result
of the resolution of these audit issues, the company has recorded favorable
adjustments to its existing tax liability reserves, which resulted in an
after-tax benefit of $68.2 million, or $.20 per diluted share, to net income
in the third quarter of 2004.
d. The company has two business segments: Services and Technology. Revenue
classifications by segment are as follows: Services - consulting and
systems integration, outsourcing, infrastructure services and core
maintenance; Technology - enterprise-class servers and specialized
technologies. The accounting policies of each business segment are the same
as those followed by the company as a whole. Intersegment sales and
transfers are priced as if the sales or transfers were to third parties.
Accordingly, the Technology segment recognizes intersegment revenue and
manufacturing profit on hardware and software shipments to customers under
Services contracts. The Services segment, in turn, recognizes customer
revenue and marketing profits on such shipments of company hardware and
software to customers. The Services segment also includes the sale of
hardware and software products sourced from third parties that are sold to
customers through the company's Services channels. In the company's
consolidated statements of income, the manufacturing costs of products
sourced from the Technology segment and sold to Services customers are
reported in cost of revenue for Services.
Also included in the Technology segment's sales and operating profit are
sales of hardware and software sold to the Services segment for internal use
in Services engagements. The amount of such profit included in operating
income of the Technology segment for the three and nine months ended
September 30, 2004 and 2003 was $7.2 million and $6.7 million, and $9.8
million and $18.6 million, respectively. The profit on these transactions
is eliminated in Corporate.
The company evaluates business segment performance on operating income
exclusive of restructuring charges and unusual and nonrecurring items, which
are included in Corporate. All other corporate and centrally incurred costs
are allocated to the business segments based principally on revenue,
employees, square footage or usage.
7
A summary of the company's operations by business segment for the three and
nine month periods ended September 30, 2004 and 2003 is presented below (in
millions of dollars):
Total Corporate Services Technology
Three Months Ended ----- --------- -------- ----------
September 30, 2004
------------------
Customer revenue $1,445.7 $1,147.1 $298.6
Intersegment $(63.6) 5.2 58.4
-------- ------- -------- ------
Total revenue $1,445.7 $(63.6) $1,152.3 $357.0
======== ======= ======== ======
Operating income (loss) $ (38.0) $(85.4) $ (2.3) $ 49.7
======== ======= ========= ======
Three Months Ended
September 30, 2003
------------------
Customer revenue $1,449.7 $1,124.3 $ 325.4
Intersegment $(66.4) 7.3 59.1
-------- ------- -------- --------
Total revenue $1,449.7 $(66.4) $1,131.6 $ 384.5
======== ====== ======== ========
Operating income (loss) $ 105.9 $ (1.3) $ 43.8 $ 63.4
======== ====== ======== ========
Nine Months Ended
September 30, 2004
------------------
Customer revenue $4,296.7 $3,470.9 $ 825.8
Intersegment $(166.6) 14.5 152.1
-------- ------- -------- --------
Total revenue $4,296.7 $(166.6) $3,485.4 $ 977.9
======== ======= ======== ========
Operating income (loss) $ 43.7 $ (85.4) $ 35.1 $ 94.0
======== ======= ======== ========
Nine Months Ended
September 30, 2003
------------------
Customer revenue $4,273.6 $3,394.7 $ 878.9
Intersegment $(225.6) 19.2 206.4
-------- ------- -------- --------
Total revenue $4,273.6 $(225.6) $3,413.9 $1,085.3
======== ======= ======== ========
Operating income (loss) $ 268.5 $( 3.6) $ 142.3 $ 129.8
======== ======= ======== ========
Presented below is a reconciliation of total business segment operating
income to consolidated income (loss) before taxes (in millions of dollars):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Total segment operating income $ 47.4 $107.2 $129.1 $272.1
Interest expense (16.2) (17.2) (51.4) (51.3)
Other income (expense), net (3.0) ( 4.7) 21.6 2.5
Corporate and eliminations 1.3 ( 1.3) 1.3 ( 3.6)
Cost reduction charge (86.7) (86.7)
------ ------ ------ ------
Total income (loss) before $(57.2) $ 84.0 $ 13.9 $219.7
income taxes ====== ====== ====== ======
8
Customer revenue by classes of similar products or services, by segment, is
presented below:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2004 2003 2004 2003
---- ---- ---- ----
Services
Consulting and systems
integration $ 403.3 $ 378.9 $1,194.3 $1,121.3
Outsourcing 411.8 396.2 1,274.2 1,227.3
Infrastructure services 193.1 207.5 572.6 620.1
Core maintenance 138.9 141.7 429.8 426.0
-------- -------- -------- -------
1,147.1 1,124.3 3,470.9 3,394.7
Technology
Enterprise-class servers 249.6 249.7 636.9 661.3
Specialized technologies 49.0 75.7 188.9 217.6
-------- -------- -------- --------
298.6 325.4 825.8 878.9
-------- -------- -------- --------
Total $1,445.7 $1,449.7 $4,296.7 $4,273.6
======== ======== ======== ========
e. Comprehensive income for the three and nine months ended September 30, 2004
and 2003 includes the following components (in millions of dollars):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net income $ 25.2 $ 56.2 $73.5 $147.2
Other comprehensive income (loss)
Cash flow hedges
Income (loss), net of tax of
$(.1), $(2.5), $.3, and $(5.1) (.2) (4.6) .7 (9.4)
Reclassification adjustments,
net of tax of $.6, $1.1 ,$2.2,
and $3.1 1.3 2.0 4.2 5.8
Foreign currency translation
adjustments 6.1 7.2 13.1 38.1
------ ------ ------ ------
Total other comprehensive
income 7.2 4.6 18.0 34.5
------ ------ ------ ------
Comprehensive income $ 32.4 $ 60.8 $91.5 $181.7
====== ====== ====== ======
Accumulated other comprehensive income (loss) is as follows (in millions of
dollars):
Cash Minimum
Translation Flow Pension
Total Adjustments Hedges Liability
----- ----------- ------ ---------
Balance at December 31, 2002 $(2,236.9) $(745.0) $( 1.5) $(1,490.4)
Change during period 225.0 65.3 ( 5.1) 164.8
--------- ------- ------ ---------
Balance at December 31, 2003 (2,011.9) (679.7) ( 6.6) (1,325.6)
Change during period 18.0 13.1 4.9
--------- ------- ------ ---------
Balance at September 30, 2004 $(1,993.9) $(666.6) $ (1.7) $(1,325.6)
========= ======= ====== =========
f. The amount credited to stockholders' equity for the income tax benefit
related to the company's stock plans for the nine months ended September 30,
2004 and 2003 was $3.6 million and $3.1 million, respectively. The company
expects to realize these tax benefits on future Federal income tax returns.
g. For equipment manufactured by the company, the company warrants that it will
substantially conform to relevant published specifications for 12 months
after shipment to the customer. The company will repair or replace, at its
option and expense, items of equipment that do not meet this warranty. For
9
company software, the company warrants that it will conform substantially to
then-current published functional specifications for 90 days from customer's
receipt. The company will provide a workaround or correction for material
errors in its software that prevents its use in a production environment.
The company estimates the costs that may be incurred under its warranties
and records a liability in the amount of such costs at the time revenue is
recognized. Factors that affect the company's warranty liability include
the number of units sold, historical and anticipated rates of warranty
claims and cost per claim. The company quarterly assesses the adequacy of
its recorded warranty liabilities and adjusts the amounts as necessary.
Presented below is a reconciliation of the aggregate product warranty
liability (in millions of dollars):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Balance at beginning
of period $15.0 $21.1 $20.8 $19.2
Accruals for warranties issued
during the period 2.0 5.5 9.1 17.2
Settlements made during the
period (3.8) (4.7) (12.7) (13.8)
Changes in liability for
pre-existing warranties during
the period, including expirations (.4) (.8) (4.4) (1.5)
----- ----- ----- -----
Balance at September 30 $12.8 $21.1 $12.8 $21.1
===== ===== ===== =====
h. The company applies the recognition and measurement principles of APB
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations in accounting for its stock-based employee compensation
plans. For stock options, no compensation expense is reflected in net
income as all stock options granted had an exercise price equal to or
greater than the market value of the underlying common stock on the date
of grant. In addition, no compensation expense is recognized for common
stock purchases under the Employee Stock Purchase Plan. Pro forma
information regarding net income and earnings per share is required by
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation," and has been determined as if the company
had accounted for its stock plans under the fair value method of SFAS No.
123. For purposes of the pro forma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting period. The
following table illustrates the effect on net income and earnings per share
if the company had applied the fair value recognition provisions of SFAS No.
123 (in millions of dollars):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
Net income as reported $ 25.2 $ 56.2 $ 73.5 $147.2
Deduct total stock-based employee
compensation expense determined
under fair value method for all
awards, net of tax ( 7.6) (10.4) (25.3) (35.2)
------ ------ ------ ------
Pro forma net income $ 17.6 $ 45.8 $ 48.2 $112.0
====== ====== ====== ======
Earnings per share
Basic - as reported $ .08 $ .17 $ .22 $ .45
Basic - pro forma $ .05 $ .14 $ .14 $ .34
Diluted - as reported $ .07 $ .17 $ .22 $ .44
Diluted - pro forma $ .05 $ .14 $ .14 $ .34
10
i. Net periodic pension expense (income) for the three and nine months ended
September 30, 2004 and 2003 is presented below (in millions of dollars):
Three Months Three Months
Ended Sept. 30, 2004 Ended Sept. 30, 2003
---------------------- ----------------------
U.S. Int'l. U.S. Int'l.
Total Plans Plans Total Plans Plans
----- ----- ----- ----- ----- -----
Service cost $ 29.2 $ 16.8 $12.4 $ 25.4 $ 14.7 $ 10.7
Interest cost 90.3 66.0 24.3 87.0 66.9 20.1
Expected return on
plan assets (123.9) (94.7) (29.2) (124.9) (100.9) (24.0)
Amortization of prior
service (benefit) cost (1.6) (1.9) .3 (2.8) (3.0) .2
Recognized net actuarial
loss 29.5 23.3 6.2 8.3 5.1 3.2
Settlement/curtailment
loss (1.5) (1.5)
----- ----- ------ ------ ------ -----
Net periodic pension
expense (income) $23.5 $ 9.5 $14.0 $ (8.5) $(17.2) $ 8.7
===== ====== ===== ======= ======= ======
Nine Months Nine Months
Ended Sept. 30, 2004 Ended Sept. 30, 2003
---------------------- ----------------------
U.S. Int'l. U.S. Int'l.
Total Plans Plans Total Plans Plans
----- ----- ----- ----- ----- -----
Service cost $87.1 $ 50.4 $ 36.7 $ 74.1 $ 44.1 $ 30.0
Interest cost 270.5 198.3 72.2 260.4 200.5 59.9
Expected return on
plan assets (370.7) (284.2) (86.5) (376.0) (302.7) (73.3)
Amortization of prior
service (benefit) cost (4.6) (5.7) 1.1 (8.1) (9.0) .9
Recognized net actuarial
loss 88.2 69.8 18.4 26.1 15.5 10.6
Settlement/curtailment
loss .7 .7
----- ----- ------ ------ ------ -----
Net periodic pension
expense (income) $70.5 $28.6 $41.9 $(22.8) $(51.6) $ 28.8
===== ===== ====== ======= ====== =====
The company currently expects to make cash contributions of approximately
$66 million to its worldwide defined benefit pension plans in 2004 compared
with $62.5 million in 2003. For the nine months ended September 30, 2004
and 2003, $41.4 million and $36.0 million, respectively of cash
contributions have been made. In accordance with regulations governing
contributions to U.S. defined benefit pension plans, the company is not
required to fund its U.S. qualified defined benefit pension plan in 2004.
Net periodic postretirement benefit expense for the three and nine months
ended Sept. 30, 2004 and 2003 is presented below (in millions of dollars):
Three Months Nine Months
Ended Sept. 30, Ended Sept. 30,
--------------- ---------------
2004 2003 2004 2003
---- ---- ---- ----
Interest cost $ 3.5 $ 3.6 $10.5 $10.8
Amortization of prior service benefit (.5) (.5) (1.5) (1.5)
Recognized net actuarial loss 1.0 .7 3.0 2.1
----- ----- ----- -----
Net periodic postretirement benefit
expense $ 4.0 $ 3.8 $12.0 $11.4
===== ===== ===== =====
The company expects to make cash contributions of approximately $25 million
to its postretirement benefit plan in 2004. For the nine months ended
September 30, 2004, $20 million of cash contributions have been made.
11
j. Substantially all of the company's investments at equity consist of Nihon
Unisys, Ltd., a publicly traded Japanese company ("NUL"). NUL is the
exclusive supplier of the company's hardware and software products in Japan.
The company owns approximately 28% of NUL's outstanding common stock. Prior
to January 1, 2004, the company's share of NUL's earnings or losses were
recorded semiannually in the second quarter and fourth quarter on a quarter-
lag basis since NUL's quarterly financial results were not available. Due
to recent regulatory changes in Japan, NUL is required to publish its
earnings quarterly. Accordingly, effective January 1, 2004, the company has
begun to record its equity earnings in NUL quarterly on a quarter-lag basis,
and recorded equity income (loss) of $(7.2) million and $7.2 million for the
three and nine months ended September 30, 2004, respectively.
k. Cash paid during the nine months ended September 30, 2004 and 2003 for
income taxes was $47.0 million and $63.2 million, respectively.
Cash paid during the nine months ended September 30, 2004 and 2003 for
interest was $57.7 million and $51.4 million, respectively.
l. In November 2003, the company purchased KPMG's Belgian consulting business
for approximately $3.3 million of cash plus assumed liabilities. The
preliminary purchase price allocation was completed in December 2003 and
assumed that the excess of the purchase price over the assets acquired and
liabilities assumed was allocated to goodwill. An outside company
completed its appraisal during the March 2004 quarter. Approximately $1.5
million of amortizable intangibles (principally customer relationships) were
identified and recorded. The intangible assets have a weighted average life
of approximately 5.5 years. The goodwill from this acquisition has been
assigned to the Services segment.
In April 2004, the company purchased the document services business unit of
Interpay Nederlands B.V. ("Interpay") for $5.2 million. This business unit
processes approximately 110 million paper-related payments a year for Dutch
banks. The purchase price was allocated to assets acquired and liabilities
assumed based on their estimated fair values, and resulted in goodwill of
$3.4 million. The acquisition provides for the company to make contingent
payments to Interpay based on the achievement of certain future revenue
levels. The contingent consideration will be recorded as additional
goodwill when the contingencies are resolved and consideration is issued or
becomes issuable. The goodwill from this acquisition has been assigned to
the Services segment.
In June 2004, the company purchased the security services and identity and
access management solutions business of ePresence, Inc., whose consultants
design and implement enterprise directory and security solutions that enable
identity management within and across organizations. The purchase price of
$10.6 million was allocated to assets acquired and liabilities assumed
based on their estimated fair values. An outside company completed its
appraisal during the September 2004 quarter. Approximately $.7 million of
amortizable intangible assets (principally customer relationships) were
identified and recorded. The intangible assets have a weighted average
life of approximately 3.8 years. The goodwill from this acquisition
(approximately $7.5 million) has been assigned to the Services segment.
In July 2004, the company purchased Baesch Computer Consulting, Inc., a
provider of technology solutions and services to the U.S. intelligence and
defense communities, for $6.0 million. The purchase price was allocated to
assets acquired and liabilities assumed based on their estimated fair
values, and resulted in goodwill of $6.3 million. The goodwill from this
acquisition has been assigned to the Services segment.
m. In January 2003, the Financial Accounting Standards Board ("FASB") issued
interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest
Entities, an interpretation of ARB 51." The primary objectives of this
interpretation are to provide guidance on the identification of entities for
which control is achieved through means other than through voting rights
("variable interest entities") and how to determine when and which business
enterprise (the "primary beneficiary") should consolidate the variable
interest entity. This new model for consolidation applies to an entity in
which either (i) the equity investors (if any) do not have a controlling
financial interest, or (ii) the equity investment at risk is insufficient to
finance that entity's activities without receiving additional subordinated
financial support from other parties. In addition, FIN 46 requires that the
primary beneficiary, as well as all other enterprises with a significant
variable interest in a variable interest entity, make additional
disclosures. Certain disclosure requirements of FIN 46 were effective for
12
financial statements issued after January 31, 2003. In December 2003, the
FASB issued FIN 46 (revised December 2003), "Consolidation of Variable
Interest Entities" ("FIN 46-R") to address certain FIN 46 implementation
issues.
The provisions of FIN 46 were applicable for variable interests in entities
obtained after January 31, 2003. The adoption of the provisions applicable
to special purpose entities ("SPE") and all other variable interests
obtained after January 31, 2003 did not have a material impact on the
company's consolidated financial position, consolidated results of
operations, or liquidity.
Effective March 31, 2004, the company adopted the provisions of FIN 46-R
applicable to Non-SPEs created prior to February 1, 2003. Adoption of
FIN 46-R had no impact on the company's consolidated financial position,
consolidated results of operations, or liquidity.
On May 19, 2004, the FASB issued Staff Position No. FAS 106-2, "Accounting
and Disclosure Requirements Related to the Medicare Prescription Drug,
Improvement and Modernization Act of 2003", ("FSP No. 106-2"). The above
Act introduces a prescription drug benefit under Medicare as well as a
federal subsidy to sponsors of retiree health care benefit plans that
provide a benefit that is at least actuarially equivalent to Medicare Part
D. FSP No. 106-2 is effective for the first interim period beginning after
June 15, 2004 and provides that an employer shall measure the accumulated
plan benefit obligation ("APBO") and net periodic postretirement benefit
cost taking into account any subsidy received under the Act. As of
September 30, 2004, the company's measurements of both the APBO and the net
postretirement benefit cost do not reflect any amounts associated with the
subsidy because the company has not yet been able to conclude whether the
benefits provided by its postretirement medical plan are actuarially
equivalent to Medicare Part D under the Act.
13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Overview
- --------
For the three months ended September 30, 2004, the company reported net
income of $25.2 million, or $.07 per diluted share, compared with $56.2
million, or $.17 per share, for the three months ended September 30, 2003.
During the quarter ended September 30, 2004, the company's results of
operations were affected by two significant items.
During the quarter, the U.S. Congressional Joint Committee on Taxation
approved an income tax refund to the company related to the settlement of
tax audit issues dating from the mid-1980s. The refund, including interest,
is approximately $40 million. After payment of related state taxes, the
company expects a net cash refund of approximately $30 million by the end of
2004 or in early 2005. As a result of the resolution of these audit issues,
the company has recorded favorable adjustments to its existing tax liability
reserves, which resulted in an after-tax benefit of $68.2 million, or $.20
per diluted share, to net income in the third quarter of 2004.
In addition, as part of its ongoing efforts to reduce its cost base and
enhance its administrative efficiency, on September 30, 2004, the company
consolidated facility space and committed to a reduction in global headcount
of about 1,400 employees, primarily in general and administrative areas.
These actions resulted in an after-tax charge to earnings of $60 million, or
$.18 per share, in the third quarter of 2004. The company anticipates these
actions will yield approximately $70 million of annualized cost savings on a
run-rate basis by the end of 2005. The company anticipates cash
requirements for these actions of about $85 million, mostly in year 2005,
before the effect of cash savings from these actions and the tax refund.
The current quarter results were also impacted by pretax pension expense of
$23.5 million compared with pretax pension income of $8.5 million in the
year-ago quarter as well as lower margins in the outsourcing business.
Results of Operations
- ---------------------
Total revenue for the quarter ended September 30, 2004 was $1.45 billion, which
was flat when compared with the quarter ended September 30, 2003. Foreign
currency translations had a 3% positive impact on revenue in the quarter when
compared with the year-ago period. In the current quarter, Services revenue
increased 2% from the prior year and Technology revenue decreased 8% from the
prior year.
U.S. revenue decreased 4% in the current quarter compared with the year-ago
period and revenue in international markets was up 3% driven by increases in
Europe and Pacific/Asia which were partially offset by declines in Latin
America. On a constant currency basis, international revenue declined 3% in the
quarter.
The company recorded $23.5 million of pension expense for the three months ended
September 30, 2004 compared with $8.5 million of pension income for the three
months ended September 30, 2003. The change was due to the following: (1) a
decline in the discount rate used for the U.S. pension plan to 6.25% at December
31, 2003 from 6.75% at December 31, 2002, (2) an increase in amortization of net
unrecognized losses, (3) lower expected returns on plan assets due to
amortization of the difference between the calculated value of plan assets and
the fair value of plan assets, and (4) for international plans, declines in
discount rates and currency translation. The company records pension income or
expense, as well as other employee-related costs such as FICA and medical
insurance costs, in operating income in the following income statement
categories: cost of sales; selling, general and administrative expenses; and
research and development expenses. The amount allocated to each income
statement line is based on where the salaries of the active employees are
charged. The company currently expects to report pension expense of
approximately $90 - $95 million in 2004 compared with pension income of $22.6
million in 2003.
Total gross profit margin was 23.6% in the third quarter of 2004 compared with
29.3% in the year-ago period. The change principally reflected a $28.1 million
charge in the current quarter relating to the cost reduction actions, lower
margins in the outsourcing business due to higher costs in the current period
relating principally to modification of two agreements, as well as pension
expense of $17.1 million in the current quarter compared with pension income of
$1.7 million in the year-ago quarter.
14
For the three months ended September 30, 2004, selling, general and
administrative expenses were $303.7 million (21.0% of revenue) compared with
$251.0 million (17.3% of revenue) for the three months ended September 30, 2003.
The increase principally reflected a $50.2 million charge in the current quarter
relating to the cost reductions actions, as well as pension expense of $4.4
million in the current year compared with $3.2 million of pension income in the
year-ago period.
Research and development ("R&D") expense was $75.3 million compared with $68.2
million a year ago. The company continues to invest in high-end Cellular
MultiProcessing server technology and in key programs within its industry
practices. R&D in the current period includes a charge relating to the cost
reductions actions of $8.4 million as well as $2.0 million of pension expense
compared with pension income of $3.6 million in the year-ago period.
For the third quarter of 2004, the company reported an operating income (loss)
percent of (2.6%) compared with 7.3% for the third quarter of 2003. The change
principally reflected a charge relating to the cost reductions actions of $86.7
million in the current quarter as well as pension expense of $23.5 million in
the current quarter compared with pension income of $8.5 million in the year-ago
period.
Interest expense for the three months ended September 30, 2004 was $16.2 million
compared with $17.2 million for the three months ended September 30, 2003.
Other income (expense), net was an expense of $3.0 million in the current
quarter compared with an expense of $4.7 million in the year-ago quarter.
Income before income taxes was a loss of $57.2 million in the third quarter of
2004 compared with $84.0 million income last year. The provision for income
taxes was a benefit of $82.4 million in the current period compared with a
provision of $27.8 million in the year-ago period. The current period includes
a benefit of $68.2 million related to the tax refund as well as a $22.0 million
benefit related to the cost reduction charge. Included in the $22.0 million tax
benefit on the cost reduction action is an increase in valuation allowances on
deferred tax assets of approximately $7 million related to countries where the
company has assessed the realization of the tax benefits to be less than likely.
For the nine months ended September 30, 2004, the company reported net income of
$73.5 million, or $.22 per diluted share, compared with $147.2 million, or $.44
per diluted share, for the nine months ended September 30, 2003.
Total revenue for the nine months ended September 30, 2004 was $4.30 billion, up
1% from revenue of $4.27 billion for the nine months ended September 30, 2003.
Foreign currency translations had a 5% positive impact on revenue in the nine
months when compared with the year-ago period. In the current nine-month
period, Services revenue increased 2% and Technology revenue decreased 6%.
U.S. revenue decreased 2% in the current nine-month period compared with the
year-ago period. Revenue in international markets increased 3% driven by an
increase in Europe which was partially offset by declines in other international
regions. On a constant currency basis, international revenue declined 6% in the
nine months ended September 30, 2004.
Pension expense for the nine months ended September 30, 2004 was $70.5 million
compared with $22.8 million of pension income for the nine months ended
September 30, 2003.
Total gross profit margin was 25.6% in the nine months ended September 30, 2004
compared with 28.2% in the year-ago period. The change principally reflected a
$28.1 million charge relating to the cost reduction actions in the current nine-
month period as well as pension expense of $50.4 million in the current period
compared with pension income of $4.4 million in the year-ago period.
For the nine months ended September 30, 2004, selling, general and
administrative expenses were $837.8 million (19.5% of revenue) compared with
$737.1 million (17.2% of revenue) for the nine months ended September 30, 2003.
Selling, general and administrative expenses in the current period includes a
$50.2 million charge relating to the cost reduction actions as well as $14.1
million of pension expense compared with pension income of $7.6 million in the
year-ago period.
15
R&D expense for the nine months ended September 30, 2004 was $218.1 million
compared with $198.7 million a year ago. R&D in the current period includes an
$8.4 million charge relating to the cost reduction actions as well as $6.0
million of pension expense compared with pension income of $10.8 million in the
year-ago period.
For the nine months ended September 30, 2004, the company reported an operating
income percent of 1.0% compared with 6.3% for the nine months ended September
30, 2003. The change principally reflected an $86.7 million charge relating to
the cost reduction actions in the current nine-month period as well as pension
expense of $70.5 million in the current period compared with pension income of
$22.8 million in the year-ago period.
Interest expense for the nine months ended September 30, 2004 was $51.4 million
compared with $51.3 million for the nine months ended September 30, 2003.
Other income (expense), net was income of $21.6 million in the current nine-
month period compared with income of $2.5 million in the year-ago period. The
increase in income was principally due to foreign exchange losses of $3.4
million in the current year compared with losses of $15.0 million in the prior-
year period as well as $4.7 million income in the current period related to
minority shareholders' portion of the cost reduction charge of a 51% owned
subsidiary which is fully consolidated by the company.
Income before income taxes was $13.9 million in the nine months ended September
30, 2004 compared with $219.7 million last year. The provision for income taxes
was a benefit of $59.6 million in the current period compared with a provision
of $72.5 million in the year-ago period. The current nine-month period includes
a benefit of $68.2 million related to the tax refund as well as a $22.0 million
benefit related to the cost reduction charge.
For 2005, pension expense cannot be reliably estimated until after December 31,
2004 when the actual amount of pension plan assets is known and the discount
rate can be determined. However, based on 2004 stock market performance
expectations as well as the long-term interest rate environment, the company's
U.S. pension expense could increase by as much as 100-200% from an expected 2004
level of $38 million. Currently the company estimates approximately $56 million
of expense for all other defined benefit pension plans for 2004; current
estimates indicate slightly higher 2005 expense for these plans.
Despite the estimated increase in 2005 pension expense, in accordance with
regulations governing contributions to U.S. defined benefit pension plans, the
company currently expects that it will not be required to fund its U.S.
qualified defined benefit pension plan in 2005. The company also currently
expects that cash contributions to its other defined benefit pension plans will
be somewhat higher than in 2004.
The 2005 pension estimates mentioned above are preliminary and can vary
significantly from actual amounts. The 2005 pension expense will be determined
in January 2005 when the December 31, 2004 employee levels, pension plan assets
and discount rates are known.
Segment results
- ---------------
The company has two business segments: Services and Technology. Revenue
classifications are as follows: Services - consulting and systems integration,
outsourcing, infrastructure services, and core maintenance; Technology -
enterprise-class servers and specialized technologies. The accounting policies
of each business segment are the same as those followed by the company as a
whole. Intersegment sales and transfers are priced as if the sales or transfers
were to third parties. Accordingly, the Technology segment recognizes
intersegment revenue and manufacturing profit on hardware and software shipments
to customers under Services contracts. The Services segment, in turn,
recognizes customer revenue and marketing profit on such shipments of company
hardware and software to customers. The Services segment also includes the sale
of hardware and software products sourced from third parties that are sold to
customers through the company's Services channels. In the company's
consolidated statements of income, the manufacturing costs of products sourced
from the Technology segment and sold to Services customers are reported in cost
of revenue for Services.
Also included in the Technology segment's sales and operating profit are sales
of hardware and software sold to the Services segment for internal use in
Services engagements. The amount of such profit included in operating income of
the Technology segment for the three months ended September 30, 2004 and 2003,
was $7.2 million and $6.7 million, respectively. The profit on these
transactions is eliminated in Corporate.
16
The company evaluates business segment performance on operating income exclusive
of restructuring charges and unusual and nonrecurring items, which are included
in Corporate. All other corporate and centrally incurred costs are allocated to
the business segments based principally on revenue, employees, square footage or
usage. Therefore, the comparisons below exclude the cost reduction items
discussed above.
Information by business segment is presented below (in millions of dollars):
Elimi-
Total nations Services Technology
------- ------- -------- ----------
Three Months Ended
September 30, 2004
- ------------------
Customer revenue $1,445.7 $1,147.1 $298.6
Intersegment $(63.6) 5.2 58.4
-------- ------- -------- ------
Total revenue $1,445.7 $(63.6) $1,152.3 $357.0
======== ======= ======== ======
Gross profit percent 23.6% 16.2% 51.0%
======== ======== ======
Operating income (loss)
percent (2.6)% (0.2)% 13.9%
======== ======== ======
Three Months Ended
September 30, 2003
- ------------------
Customer revenue $1,449.7 $1,124.3 $325.4
Intersegment $( 66.4) 7.3 59.1
-------- ------- -------- ------
Total revenue $1,449.7 $( 66.4) $1,131.6 $384.5
======== ======= ======== ======
Gross profit percent 29.3% 19.8% 53.1%
======== ======== ======
Operating income
percent 7.3% 3.9% 16.5%
======== ======== ======
Gross profit percent and operating income percent are as a percent of total
revenue.
In the Services segment, customer revenue was $1.15 billion for the three months
ended September 30, 2004, compared with $1.12 billion for the three months ended
September 30, 2003. Foreign currency translations had about a 3% positive
impact on Services revenue in the quarter when compared with the year-ago
period. Consulting and systems integration revenue grew 6% ($403 million in
2004 compared with $379 million in 2003) and outsourcing revenue grew 4% ($412
million in 2004 compared with $396 million in 2003). These increases were
partially offset by a 2% decline in core maintenance revenue ($139 million in
2004 compared with $142 million in 2003) and a 7% decline in infrastructure
services revenue ($193 million in 2004 compared with $207 million in 2003).
Services gross profit was 16.2% for the three months ended September 30, 2004
compared with 19.8% in the year-ago period. This change was principally due to
the impact of pension expense of $16.7 million in the current quarter compared
with pension income of $1.0 million in the year-ago period as well as higher
costs in the current period relating to modifications of two outsourcing
agreements. Services operating income percent was (0.2)% for the three months
ended September 30, 2004 compared with 3.9% last year. The principal reason for
the decline in operating income was due to the impact of pension accounting. In
the current period, operating profit included $20.6 million of pension expense
compared with pension income of $3.9 million in the year-ago quarter. The
remaining reason for the decline in operating income related to modifications of
two outsourcing agreements, which resulted in higher current-period cost and a
write down to net realizable value of certain outsourcing assets related to such
agreements.
17
In the Technology segment, customer revenue was $299 million for the three
months ended September 30, 2004, down 8% compared with $325 million for the
three months ended September 30, 2003. Foreign currency translations had about
a 3% positive impact on Technology revenue in the quarter when compared with the
year-ago period. The decrease in revenue was due to a 35% decrease in sales of
specialized technology products ($49 million in 2004 compared with $75 million
in 2003). Sales of enterprise-class servers were flat at $249.6 million
compared with the year-ago period. The decrease in specialized technology
revenue was caused by lower sales of semiconductor test systems and payment
systems. Sales of these systems can vary significantly from quarter to quarter
depending on customer needs. Technology gross profit was 51.0% for the three
months ended September 30, 2004 compared with 53.1% in the year-ago period, and
Technology operating income percent was 13.9% for the three months ended
September 30, 2004 compared with 16.5% last year. The gross profit decrease
primarily reflected a lower proportion of higher-margin products within the
specialized technology product line. The decline in operating income percent
was principally due to pension expense of $2.9 million in the current period
compared with pension income of $4.6 million in the prior-year period.
New Accounting Pronouncements
- -----------------------------
In January 2003, the Financial Accounting Standards Board ("FASB") issued
interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities,
an interpretation of ARB 51." The primary objectives of this interpretation are
to provide guidance on the identification of entities for which control is
achieved through means other than through voting rights ("variable interest
entities") and how to determine when and which business enterprise (the "primary
beneficiary") should consolidate the variable interest entity. This new model
for consolidation applies to an entity in which either (i) the equity investors
(if any) do not have a controlling financial interest, or (ii) the equity
investment at risk is insufficient to finance that entity's activities without
receiving additional subordinated financial support from other parties. In
addition, FIN 46 requires that the primary beneficiary, as well as all other
enterprises with a significant variable interest in a variable interest entity,
make additional disclosures. Certain disclosure requirements of FIN 46 were
effective for financial statements issued after January 31, 2003. In December
2003, the FASB issued FIN 46 (revised December 2003), "Consolidation of Variable
Interest Entities" ("FIN 46-R") to address certain FIN 46 implementation issues.
The provisions of FIN 46 were applicable for variable interests in entities
obtained after January 31, 2003. The adoption of the provisions applicable to
special purpose entities ("SPE") and all other variable interests obtained after
January 31, 2003 did not have a material impact on the company's consolidated
financial position, consolidated results of operations, or liquidity.
Effective March 31, 2004, the company adopted the provisions of FIN 46-R
applicable to Non-SPEs created prior to February 1, 2003. Adoption of FIN 46-R
had no impact on the company's consolidated financial position, consolidated
results of operations, or liquidity.
On May 19, 2004, the FASB issued Staff Position No. FAS 106-2, "Accounting and
Disclosure Requirements Related to the Medicare Prescription Drug, Improvement
and Modernization Act of 2003", ("FSP No. 106-2"). The above Act introduces a
prescription drug benefit under Medicare as well as a federal subsidy to
sponsors of retiree health care benefit plans that provide a benefit that is at
least actuarially equivalent to Medicare Part D. FSP No. 106-2 is effective for
the first interim period beginning after June 15, 2004 and provides that an
employer shall measure the accumulated plan benefit obligation ("APBO") and net
periodic postretirement benefit cost taking into account any subsidy received
under the Act. As of September 30, 2004, the company's measurements of both the
APBO and the net postretirement benefit cost do not reflect any amounts
associated with the subsidy because the company has not yet been able to
conclude whether the benefits provided by its postretirement medical plan are
actuarially equivalent to Medicare Part D under the Act.
Financial Condition
- -------------------
Cash and cash equivalents at September 30, 2004 were $573.7 million compared
with $635.9 million at December 31, 2003.
During the nine months ended September 30, 2004, cash provided by operations was
$213.2 million compared with $162.1 million for the nine months ended September
30, 2003. Operating cash flow increased principally due to lower expenditures
on prior-year restructuring and improved working capital management. Cash
expenditures in the nine months ended September 30, 2004 related to prior-year
restructuring charges (which are included in operating activities) were
approximately $10 million compared with $51 million for the prior-year period.
Cash expenditures for the 2004 cost reduction actions are expected to be
approximately $3 million for the remainder of 2004 and $82 million in total for
all subsequent years (primarily in 2005), principally for work-force reductions.
18
Cash used for investing activities for the nine months ended September 30, 2004
was $303.8 million compared with $326.4 million during the nine months ended
September 30, 2003. The decrease in cash used was principally due to net
purchases of investments of $4.0 million in the current period compared with net
purchases of $37.1 million in the prior-year period. In addition, the current
period investment in marketable software was $88.8 million compared with $109.4
million in the prior-year. Capital additions were $192.4 million for the nine
months ended September 30, 2004 compared with $177.9 million in the prior-year
period. The increase in current year capital expenditures was principally
related to the move of the company's Federal headquarters into a new facility.
Cash expenditures for purchases of businesses was $18.6 million for the nine
months ended September 30, 2004 compared with $2.0 million in the prior year.
Cash provided by financing activities during the nine months ended September 30,
2004 was $27.6 million compared with $253.5 million in the prior year. The
prior period includes net proceeds from issuance of long-term debt of $293.3
million in connection with the company's issuance in March 2003 of $300 million
of 6 7/8% senior notes due 2010.
At September 30, 2004 and December 31, 2003, total debt was $1.1 billion.
The company has a $500 million credit agreement that expires in May 2006. As of
September 30, 2004, there were no borrowings under this facility, and the entire
$500 million was available for borrowings. Borrowings under the agreement bear
interest based on the then-current LIBOR or prime rates and the company's credit
rating. The credit agreement contains financial and other covenants, including
maintenance of certain financial ratios, a minimum level of net worth and
limitations on certain types of transactions, which could reduce the amount the
company is able to borrow. Events of default under the credit agreement include
failure to perform covenants, material adverse change, change of control and
default under other debt aggregating at least $25 million. If an event of
default were to occur under the credit agreement, the lenders would be entitled
to declare all amounts borrowed under it immediately due and payable. The
occurrence of an event of default under the credit agreement could also cause
the acceleration of obligations under certain other agreements and the
termination of the company's U.S. trade accounts receivable facility, described
below.
In addition, the company and certain international subsidiaries have access to
certain uncommitted lines of credit from various banks. Other sources of short-
term funding are operational cash flows, including customer prepayments, and the
company's U.S. trade accounts receivable facility. Using this facility, the
company sells, on an on-going basis, up to $225 million of its eligible U.S.
trade accounts receivable through a wholly owned subsidiary, Unisys Funding
Corporation I. The facility is renewable annually at the purchasers' option and
expires in December 2006. At both September 30, 2004 and December 31, 2003, the
company had sold $225 million of eligible receivables.
At September 30, 2004, the company has met all covenants and conditions under
its various lending and funding agreements. Since the company believes that it
will continue to meet these covenants and conditions, the company believes that
it has adequate sources and availability of short-term funding to meet its
expected cash requirements.
The company may, from time to time, redeem, tender for, or repurchase its
securities in the open market or in privately negotiated transactions depending
upon availability, market conditions and other factors.
The company has on file with the Securities and Exchange Commission a
registration statement covering $1.2 billion of debt or equity securities, which
enables the company to be prepared for future market opportunities.
At September 30, 2004, the company had deferred tax assets in excess of deferred
tax liabilities of $2,073 million. For the reasons cited below, management
determined that it is more likely than not that $1,609 million of such assets
will be realized, therefore resulting in a valuation allowance of $464 million.
The American Jobs Creation Act of 2004 extends the excess foreign tax credit
carryforward period from five to ten years and limits the carryback period to
one year. This should provide the company with more opportunities to fully
utilize its foreign tax credits.
19
The company evaluates quarterly the realizability of its deferred tax assets
and adjusts the amount of the related valuation allowance, if necessary. The
factors used to assess the likelihood of realization are the company's forecast
of future taxable income, and available tax planning strategies that could be
implemented to realize deferred tax assets. Approximately $4.9 billion of
future taxable income (predominantly U.S.) is needed to realize all of the net
deferred tax assets. Failure to achieve forecasted taxable income might affect
the ultimate realization of the net deferred tax assets. See "Factors That May
Affect Future Results" below.
Stockholders' equity increased $142.4 million during the nine months ended
September 30, 2004, principally reflecting net income of $73.5 million, $47.2
million for issuance of stock under stock option and other plans, $3.6 million
of tax benefits related to employee stock plans and currency translation of
$13.1 million.
At December 31 of each year, accounting rules require a company to recognize a
liability on its balance sheet for each defined benefit pension plan if the fair
value of the assets of that pension plan is less than the present value of the
pension obligation (the accumulated benefit obligation, or "ABO"). This
liability is called a "minimum pension liability." Concurrently, any existing
prepaid pension asset for the pension plan must be removed. These adjustments
are recorded as a charge in "accumulated other comprehensive income (loss)" in
stockholders' equity. If at any future year-end, the fair value of the pension
plan assets exceeds the ABO, the charge to stockholders' equity would be
reversed for such plan. Alternatively, if the fair market value of pension plan
assets experiences further declines or the discount rate is reduced, additional
charges to accumulated other comprehensive income (loss) may be required at a
future year-end.
At December 31, 2002, for all of the company's defined benefit pension plans,
the ABO exceeded the fair value of pension plan assets. At December 31, 2003,
the difference between the ABO and the fair value of pension plan assets
decreased. As a result, at December 31, 2003, the company adjusted its minimum
pension liability as follows: decreased its pension plan liabilities by
approximately $300 million, increased its investments at equity by approximately
$6 million relating to the company's share of the change in NUL's minimum
pension liability, decreased prepaid pension asset by $56 million, and offset
these changes by a credit to other comprehensive income of approximately $250
million, or $165 million net of tax.
This accounting has no effect on the company's net income, liquidity or cash
lows. Financial ratios and net worth covenants in the company's credit
agreements and debt securities are unaffected by charges or credits to
stockholders' equity caused by adjusting a minimum pension liability.
In accordance with regulations governing contributions to U.S. defined benefit
pension plans, the company is not required to fund its U.S. qualified defined
benefit plan in 2004. The company expects to make cash contributions of
approximately $66 million to its other defined benefit pension plans during
2004.
Factors That May Affect Future Results
- --------------------------------------
From time to time, the company provides information containing "forward-looking"
statements, as defined in the Private Securities Litigation Reform Act of 1995.
Forward-looking statements provide current expectations of future events and
include any statement that does not directly relate to any historical or current
fact. Words such as "anticipates," "believes," "expects," "intends," "plans,"
"projects" and similar expressions may identify such forward-looking statements.
All forward-looking statements rely on assumptions and are subject to risks,
uncertainties and other factors that could cause the company's actual results to
differ materially from expectations. Statements in this report concerning
anticipated savings from cost reduction actions are subject to the risk that the
company may not implement the headcount reductions as quickly or as fully as
currently planned. Other factors that could affect future results include, but
are not limited to, those discussed below. Any forward-looking statement speaks
only as of the date on which that statement is made. The company assumes no
obligation to update any forward-looking statement to reflect events or
circumstances that occur after the date on which the statement is made.
20
The company's business is affected by changes in general economic and business
conditions. The company continues to face a highly competitive business
environment and economic weakness in certain geographic regions. In this
environment, many organizations are delaying planned purchases of information
technology products and services. If the level of demand for the company's
products and services declines in the future, the company's business could be
adversely affected. The company's business could also be affected by acts of
war, terrorism or natural disasters. Current world tensions could escalate and
this could have unpredictable consequences on the world economy and on our
business.
The information services and technology markets in which the company operates
include a large number of companies vying for customers and market share both
domestically and internationally. The company's competitors include consulting
and other professional services firms, systems integrators, outsourcing
providers, infrastructure services providers, computer hardware manufacturers
and software providers. Some of the company's competitors may develop competing
products and services that offer better price performance or that reach the
market in advance of the company's offerings. Some competitors also have or may
develop greater financial and other resources than the company, with enhanced
ability to compete for market share, in some instances through significant
economic incentives to secure contracts. Some also may be better able to compete
for skilled professionals. Any of these factors could have an adverse effect on
the company's business. Future results will depend on the company's ability to
mitigate the effects of aggressive competition on revenues, pricing and margins
and on the company's ability to attract and retain talented people.
The company operates in a highly volatile industry characterized by rapid
technological change, evolving technology standards, short product life cycles
and continually changing customer demand patterns. Future success will depend in
part on the company's ability to anticipate and respond to these market trends
and to design, develop, introduce, deliver or obtain new and innovative products
and services on a timely and cost-effective basis. The company may not be
successful in anticipating or responding to changes in technology, industry
standards or customer preferences, and the market may not demand or accept its
services and product offerings. In addition, products and services developed by
competitors may make the company's offerings less competitive.
The company's future results will depend in part on its ability to grow
outsourcing and infrastructure services. The company's outsourcing contracts
are multiyear engagements under which the company takes over management of a
client's technology operations, business processes or networks. The company
will need to maintain a strong financial position in order to grow its
outsourcing business. In a number of these arrangements, the company hires
certain of its clients' employees and may become responsible for the related
employee obligations, such as pension and severance commitments. In addition,
system development activity on outsourcing contracts may require the company to
make significant upfront investments.
As long-term relationships, outsourcing contracts provide a base of recurring
revenue. However, outsourcing contracts are highly complex, and can involve the
design, development, implementation and operation of new solutions and the
transitioning of clients from their existing business processes to the new
environment. In the early phases of these contracts, gross margins may be lower
than in later years when an integrated solution has been implemented, the
duplicate costs of transitioning from the old to the new system have been
eliminated and the work force and facilities have been rationalized for
efficient operations. Future results will depend on the company's ability to
effectively and timely complete these implementations, transitions and
rationalizations.
Future results will also depend in part on the company's ability to drive
profitable growth in consulting and systems integration. The company's ability
to grow profitably in this business will depend in part on an improvement in
economic conditions and a pick-up in demand for systems integration projects. It
will also depend on the success of the actions the company has taken to enhance
the skills base and management team in this business and to refocus the business
on integrating best-of-breed, standards-based solutions to solve client needs.
In addition, profit margins in this business are largely a function of the rates
the company is able to charge for services and the chargeability of its
professionals. If the company is unable to maintain the rates it charges or
appropriate chargeability for its professionals, profit margins will suffer.
The rates the company is able to charge for services are affected by a number of
factors, including clients' perception of the company's ability to add value
through its services; introduction of new services or products by the company or
its competitors; pricing policies of competitors; and general economic
conditions. Chargeability is also affected by a number of factors, including the
company's ability to transition employees from completed projects to new
engagements, and its ability to forecast demand for services and thereby
maintain an appropriate head count.
21
Future results will also depend, in part, on market acceptance of the company's
high-end enterprise servers. In its technology business, the company is focusing
its resources on high-end enterprise servers based on its Cellular
MultiProcessing (CMP) architecture. The company's CMP servers are designed to
provide mainframe-class capabilities with compelling price-performance by making
use of standards-based technologies such as Intel chips and Microsoft operating
system software. The company has transitioned both its legacy ClearPath servers
and its Intel-based ES7000s to the CMP platform, creating a common platform for
all the company's high-end server lines. Future results will depend, in part, on
customer acceptance of the new CMP-based ClearPath Plus systems and the
company's ability to maintain its installed base for ClearPath and to develop
next-generation ClearPath products that are purchased by the installed base. In
addition, future results will depend, in part, on the company's ability to
generate new customers and increase sales of the Intel-based ES7000 line. The
company believes there is significant growth potential in the developing market
for high-end, Intel-based servers running Microsoft and Linux operating system
software. However, competition in these new markets is likely to intensify in
coming years, and the company's ability to succeed will depend on its ability to
compete effectively against enterprise server competitors with more substantial
resources and its ability to achieve market acceptance of the ES7000 technology
by clients, systems integrators, and independent software vendors.
A number of the company's long-term contracts for infrastructure services,
outsourcing, help desk and similar services do not provide for minimum
transaction volumes. As a result, revenue levels are not guaranteed. In
addition, some of these contracts may permit termination or may impose other
penalties if the company does not meet the performance levels specified in the
contracts.
Some of the company's systems integration contracts are fixed-priced contracts
under which the company assumes the risk for delivery of the contracted services
and products at an agreed-upon fixed price. At times the company has experienced
problems in performing some of these fixed-price contracts on a profitable basis
and has provided periodically for adjustments to the estimated cost to complete
them. Future results will depend on the company's ability to perform these
services contracts profitably.
The company frequently enters into contracts with governmental entities. Risks
and uncertainties associated with these government contracts include the
availability of appropriated funds and contractual provisions that allow
governmental entities to terminate agreements at their discretion before the end
of their terms.
The success of the company's business is dependent on strong, long-term client
relationships and on its reputation for responsiveness and quality. As a result,
if a client is not satisfied with the company's services or products, its
reputation could be damaged and its business adversely affected. In addition, if
the company fails to meet its contractual obligations, it could be subject to
legal liability, which could adversely affect its business, operating results
and financial condition.
The company has commercial relationships with suppliers, channel partners and
other parties that have complementary products, services or skills. Future
results will depend, in part, on the performance and capabilities of these third
parties, on the ability of external suppliers to deliver components at
reasonable prices and in a timely manner, and on the financial condition of, and
the company's relationship with, distributors and other indirect channel
partners.
Approximately 54% of the company's total revenue derives from international
operations. The risks of doing business internationally include foreign currency
exchange rate fluctuations, changes in political or economic conditions, trade
protection measures, import or export licensing requirements, multiple and
possibly overlapping and conflicting tax laws, and weaker intellectual property
protections in some jurisdictions.
The company cannot be sure that its services and products do not infringe on the
intellectual property rights of third parties, and it may have infringement
claims asserted against it or against its clients. These claims could cost the
company money, prevent it from offering some services or products, or damage its
reputation.
22
Item 4. Controls and Procedures
- ---------------------------------
The company's management, with the participation of the company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the company's disclosure controls and procedures as of September 30, 2004.
Based on this evaluation, the company's Chief Executive Officer and Chief
Financial Officer concluded that the company's disclosure controls and
procedures are effective for gathering, analyzing and disclosing the information
the company is required to disclose in the reports it files under the Securities
Exchange Act of 1934, within the time periods specified in the SEC's rules and
forms. Such evaluation did not identify any change in the company's internal
control over financial reporting that occurred during the quarter ended
September 30, 2004 that has materially affected, or is reasonably likely to
materially affect, the company's internal control over financial reporting.
Part II - OTHER INFORMATION
- ------- -----------------
Item 5. Other Information
- ------- -----------------
(a) The company's independent auditor, Ernst & Young LLP (E&Y), has recently
notified the SEC, the Public Company Accounting Oversight Board and the audit
committee of the company's board of directors that certain non-audit work it
has performed in China has raised questions regarding E&Y's independence with
respect to its performance of audit services for the company.
During the period from January 2001 to July 2003, E&Y performed tax calculation
and tax preparation services for certain of the company's subsidiaries in China
and Taiwan for fees aggregating approximately $48,000 over the period. E&Y
disclosed that, in the course of providing these services, its affiliates in
China held tax related funds of the subsidiaries and paid such funds to the
applicable tax authorities in settlement of the relevant taxes. Having custody
of the assets of an audit client is not permitted under the auditor independence
rules in Regulation S-X of the SEC. E&Y discontinued this handling of funds in
mid 2003.
The company's audit committee and E&Y have considered the impact that the
holding and paying of these funds may have had on E&Y's independence with
respect to the company, and each has concluded that there has been no impairment
of E&Y's independence. In making this determination, the company's audit
committee considered the ministerial nature of the actions, that the
subsidiaries involved were not material to the consolidated financial statements
of the company and that neither the amount of associated fees received by E&Y
nor the amount of funds involved was significant. In addition, E&Y has informed
the company that none of its personnel involved in providing these tax services
performed any audit or audit-related services for the company.
Item 6. Exhibits
- ------- --------
See Exhibit Index
23
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
UNISYS CORPORATION
Date: October 22, 2004 By: /s/ Janet M. Brutschea Haugen
-----------------------------
Janet M. Brutschea Haugen
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
By: /s/ Carol S. Sabochick
----------------------
Carol S. Sabochick
Vice President and
Corporate Controller
(Chief Accounting Officer)
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
3.1 Restated Certificate of Incorporation of Unisys Corporation
(incorporated by reference to Exhibit 3.1 to the registrant's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1999)
3.2 Bylaws of Unisys Corporation, as amended through April 22, 2004
(incorporated by reference to Exhibit 3 to the registrant's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 2004)
12 Statement of Computation of Ratio of Earnings to Fixed Charges
31.1 Certification of Lawrence A. Weinbach required by Rule 13a-14(a)
or Rule 15d-14(a)
31.2 Certification of Janet Brutschea Haugen required by Rule 13a-14(a)
or Rule 15d-14(a)
32.1 Certification of Lawrence A. Weinbach required by Rule 13a-14(b)
or Rule 15d-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350
32.2 Certification of Janet Brutschea Haugen required by Rule 13a-14(b)
or Rule 15d-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350