News Column

UNISYS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 1, 2014

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The company's results in the first half of 2014 were impacted by lower revenue from enterprise servers, systems integration and infrastructure services. The lower revenue as well as execution issues on a few projects impacted margins and resulted in a net loss for the first six months of 2014. The company reported a first half 2014 net loss attributable to Unisys Corporation common shareholders of $65.6 million, or $1.35 per diluted share, compared with first half 2013 net loss attributable to Unisys Corporation common shareholders of $13.5 million, or $.31 per diluted share.



Revenue for the six months ended June 30, 2014 declined 6 percent to $1,568.1 million compared with $1,668.5 million for the six months ended June 30, 2013.

Results of operations Company results



Three months ended June 30, 2014 compared with the three months ended June 30, 2013

Revenue for the quarter ended June 30, 2014 was $806.4 million compared with $858.6 million for the second quarter of 2013, a decrease of 6% from the prior year. Foreign currency fluctuations had a 1-percentage-point positive impact on revenue in the current period compared with the year-ago period. Services revenue decreased 4% and Technology revenue decreased 21% in the current quarter compared with the year-ago period. U.S. revenue decreased 10% in the second quarter compared with the year-ago period, principally due to a decline in Technology revenue. International revenue decreased 3% in the current quarter principally due to declines in Asia/Pacific and Latin America, 15 -------------------------------------------------------------------------------- excluding Brazil, partially offset by increases in Europe and Brazil. Foreign currency had a 1-percentage-point positive impact on international revenue in the three months ended June 30, 2014 compared with the three months ended June 30, 2013.



Total gross profit margin was 20.5% in the three months ended June 30, 2014 compared with 23.4% in the three months ended June 30, 2013, reflecting lower margins in both the Technology and Services segments.

Selling, general and administrative expense in the three months ended June 30, 2014 was $133.6 million (16.6% of revenue) compared with $144.9 million (16.9% of revenue) in the year-ago period. Continuing tight cost controls contributed to the decline.



Research and development (R&D) expenses in the second quarter of 2014 were $15.8 million compared with $17.8 million in the second quarter of 2013.

For the second quarter of 2014, the company reported an operating profit of $15.8 million compared with $38.0 million in the second quarter of 2013.

For the three months ended June 30, 2014, pension expense was $17.9 million compared with pension expense of $22.8 million for the three months ended June 30, 2013. For the full year 2014, the company expects to recognize pension expense of approximately $75 million compared with $93.5 million for the full year of 2013. The company records pension income or expense, as well as other employee-related costs such as payroll taxes and medical insurance costs, in operating income in the following income statement categories: cost of revenue; selling, general and administrative expenses; and research and development expenses. The amount allocated to each category is principally based on where the salaries of active employees are charged.



Interest expense for the three months ended June 30, 2014 was $2.3 million compared with $2.6 million for the three months ended June 30, 2013.

Other income (expense), net was an expense of $2.5 million in the second quarter of 2014 compared with income of $14.1 million in 2013. Included in the second quarter of 2014 and 2013 were foreign exchange losses of $4.0 million and foreign exchange gains of $15.7 million, respectively. Income before income taxes for the three months ended June 30, 2014 was $11.0 million compared with $49.5 million for the three months ended June 30, 2013. The provision for income taxes was $19.9 million in the current quarter compared with $22.7 million in the year-ago period. As discussed in note (i) of the Notes to Consolidated Financial Statements, the company evaluates quarterly the realizability of its deferred tax assets by assessing its valuation allowance and by adjusting the amount of such allowance, if necessary. The company records a tax provision or benefit for those international subsidiaries that do not have a full valuation allowance against their net deferred tax assets. Any profit or loss recorded for the company's U.S. operations has no provision or benefit associated with it due to a full valuation allowance. As a result, the company's provision or benefit for taxes may vary significantly quarter to quarter depending on the geographic distribution of income. Net income attributable to Unisys Corporation common shareholders for the three months ended June 30, 2014 was a loss of $12.1 million, or a loss of $.24 per diluted share, compared with net income attributable to Unisys Corporation common shareholders of $20.4 million, or $.46 per diluted share, for the three months ended June 30, 2013.



Six months ended June 30, 2014 compared with the six months ended June 30, 2013

Revenue for the six months ended June 30, 2014 was $1,568.1 million compared with $1,668.5 million for the six months ended June 30, 2013. Foreign currency fluctuations had a negligible impact on revenue in the current period compared with the year-ago period. Services revenue decreased 4% and Technology revenue decreased 20% in the first half of 2014 compared with the year-ago period. U.S. revenue decreased 8% in the first half of 2014 compared with the year-ago period, principally due to a decline in Technology revenue. International revenue decreased 5% in the current period principally due to declines in Asia/Pacific and Latin America partially offset by an increase in Europe. Foreign currency had a 1-percentage-point negative impact on international revenue in the six months ended June 30, 2014 compared with the six months ended June 30, 2013. 16



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Total gross profit margin was 19.0% in the six months ended June 30, 2014 compared with 21.7% in the six months ended June 30, 2013, reflecting lower margins in both the Technology and Services segments.

Selling, general and administrative expense in the six months ended June 30, 2014 was $272.1 million (17.4% of revenue) compared with $287.1 million (17.2% of revenue) in the year-ago period.



Research and development (R&D) expenses in the first half of 2014 were $30.2 million compared with $34.8 million in the first half of 2013.

For the first half of 2014, the company reported an operating loss of $4.1 million compared with an operating profit of $39.6 million in the first half of 2013.

For the six months ended June 30, 2014, pension expense was $37.4 million compared with pension expense of $46.0 million for the six months ended June 30, 2013.

Interest expense for the six months ended June 30, 2014 was $4.3 million compared with $5.3 million for the six months ended June 30, 2013.

Other income (expense), net was an expense of $12.3 million in the first half of 2014 compared with income of $9.2 million in 2013. Included in the first half of 2014 and 2013 were foreign exchange losses of $13.1 million and foreign exchange gains of $11.5 million, respectively. Income before income taxes for the six months ended June 30, 2014 was a loss of $20.7 million compared with income of $43.5 million for the six months ended June 30, 2013. The provision for income taxes was $35.9 million in the current period compared with $44.1 million in the year-ago period.



Segment results

The company has two business segments: Services and Technology. Revenue classifications by segment are as follows: Services - systems integration and consulting, outsourcing, infrastructure services and core maintenance; Technology - enterprise-class software and servers and other technology.

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 months ended June 30, 2014 and 2013 was zero and $2.4 million, respectively. The amount for the six months ended June 30, 2014 and 2013 was $.4 million and $2.7 million, respectively. The profit on these transactions is eliminated in Corporate. The company evaluates business segment performance based on operating income exclusive of pension income or expense, 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. 17



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Three months ended June 30, 2014 compared with the three months ended June 30, 2013

Information by business segment is presented below (in millions of dollars): Total Eliminations Services Technology Three Months Ended June 30, 2014 Customer revenue $ 806.4$ 712.9$ 93.5 Intersegment $ (13.8 ) .1 13.7 Total revenue $ 806.4$ (13.8 )$ 713.0$ 107.2 Gross profit percent 20.5 % 16.8 % 50.2 % Operating profit percent 2.0 % 4.0 % 1.9 % Three Months Ended June 30, 2013 Customer revenue $ 858.6$ 739.7$ 118.9 Intersegment $ (16.9 ) .4 16.5 Total revenue $ 858.6$ (16.9 )$ 740.1$ 135.4 Gross profit percent 23.4 % 18.2 % 59.4 % Operating profit percent 4.4 % 4.0 % 23.9 %



Gross profit percent and operating income percent are as a percent of total revenue.

Customer revenue by classes of similar products or services, by segment, is presented below (in millions of dollars):

Three Months Ended June 30 Percent 2014 2013 Change Services



Systems integration and consulting $ 216.4$ 234.7 (7.8 )%

Outsourcing 362.0 354.7



2.1 %

Infrastructure services 89.0 105.5 (15.6 )% Core maintenance 45.5 44.8 1.6 % 712.9 739.7 (3.6 )% Technology Enterprise-class software and servers 90.8 112.2 (19.1 )% Other technology 2.7 6.7 (59.7 )% 93.5 118.9 (21.4 )% $ 806.4$ 858.6 (6.1 )% In the Services segment, customer revenue was $712.9 million for the three months ended June 30, 2014, down 3.6% from the three months ended June 30, 2013. Foreign currency translation had a negligible impact on Services revenue in the current quarter compared with the year-ago period. Revenue from systems integration and consulting, which was impacted by execution issues on a few projects as well as lower in-quarter project work when compared with the prior-year period, decreased 7.8% to $216.4 million in the June 2014 quarter from $234.7 million in the June 2013 quarter. 18 -------------------------------------------------------------------------------- Outsourcing revenue increased 2.1% for the three months ended June 30, 2014 to $362.0 million compared with the three months ended June 30, 2013. Infrastructure services revenue decreased 15.6% for the three month period ended June 30, 2014 compared with the three month period ended June 30, 2013. The decline reflects lower volume on some existing contracts and the conclusion of other contracts.



Core maintenance revenue increased 1.6% in the current quarter compared with the prior-year quarter.

Services gross profit was 16.8% in the second quarter of 2014 compared with 18.2% in the year-ago period. The current period gross profit margin was impacted by lower volume in the systems integration and infrastructure services businesses as well as execution issues on a few IT services projects. Services operating income percent was 4.0% in the three months ended June 30, 2014 compared with 4.0% in the three months ended June 30, 2013, as lower operating expenses offset the decline in gross profit margin. In the Technology segment, customer revenue decreased 21.4% to $93.5 million in the current quarter compared with $118.9 million in the year-ago period, driven by lower sales of ClearPath products. Foreign currency translation had a positive impact of approximately 1-percentage point on Technology revenue in the current period compared with the prior-year period. Revenue from the company's enterprise-class software and servers decreased 19.1% for the three months ended June 30, 2014 compared with the three months ended June 30, 2013. The decrease was due to lower sales of the company's ClearPath products. Revenue from other technology decreased $4.0 million for the three months ended June 30, 2014 compared with the three months ended June 30, 2013, principally due to lower sales of third-party technology products. Technology gross profit was 50.2% in the current quarter compared with 59.4% in the year-ago quarter. Technology operating profit percent was 1.9% in the three months ended June 30, 2014 compared with 23.9% in the three months ended June 30, 2013. The Technology segment's margins were down due to lower sales of ClearPath products.



Six months ended June 30, 2014 compared with the six months ended June 30, 2013

Information by business segment is presented below (in millions of dollars): Total Eliminations Services Technology Six Months Ended June 30, 2014 Customer revenue $ 1,568.1$ 1,403.8$ 164.3 Intersegment $ (23.4 ) .3 23.1 Total revenue $ 1,568.1$ (23.4 )$ 1,404.1$ 187.4 Gross profit percent 19.0 % 16.3 % 46.9 % Operating profit (loss) percent (.3 )% 3.0 % (8.0 )% Six Months Ended June 30, 2013 Customer revenue $ 1,668.5$ 1,462.7$ 205.8 Intersegment $ (34.2 ) .9 33.3 Total revenue $ 1,668.5$ (34.2 )$ 1,463.6$ 239.1 Gross profit percent 21.7 % 17.8 % 53.5 % Operating profit percent 2.4 % 3.5 % 13.6 %



Gross profit percent and operating income percent are as a percent of total revenue.

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Customer revenue by classes of similar products or services, by segment, is presented below (in millions of dollars):

Six Months Ended June 30 Percent 2014 2013 Change Services



Systems integration and consulting $ 427.4$ 446.5

(4.3 )%

Outsourcing 703.5 716.0



(1.7 )%

Infrastructure services 181.8 210.6

(13.7 )% Core maintenance 91.1 89.6 1.7 % 1,403.8 1,462.7 (4.0 )% Technology



Enterprise-class software and servers 153.4 192.2

(20.2 )% Other technology 10.9 13.6 (19.9 )% 164.3 205.8 (20.2 )% Total $ 1,568.1$ 1,668.5 (6.0 )% In the Services segment, customer revenue was $1,403.8 million for the six months ended June 30, 2014, a decline of 4.0% when compared with the six months ended June 30, 2013. Foreign currency translation had a negligible impact on Services revenue in the current period compared with the year-ago period. Revenue from systems integration and consulting was $427.4 million for the six months ended June 30, 2014 compared with $446.5 million for the six months ended June 30, 2013. The current-year period was impacted by execution issues on a few projects as well as lower in-period project work when compared with the prior-year period.



Outsourcing revenue decreased 1.7% for the six months ended June 30, 2014 to $703.5 million compared with the six months ended June 30, 2013.

Infrastructure services revenue decreased 13.7% for the six month period ended June 30, 2014 compared with the six month period ended June 30, 2013. The decline reflects lower volume on some existing contracts and the conclusion of other contracts.



Core maintenance revenue increased 1.7% in the current six-month period compared with the prior-year period.

Services gross profit was 16.3% in the first half of 2014 compared with 17.8% in the year-ago period. Services operating profit percent was 3.0% in the six months ended June 30, 2014 compared with 3.5% in the six months ended June 30, 2013. The current period was impacted by lower volume in the systems integration and infrastructure services businesses as well as execution issues on a few IT services projects. In the Technology segment, customer revenue decreased 20.2% to $164.3 million in the first half of 2014 compared with $205.8 million in the year-ago period. Foreign currency translation had a negligible impact on Technology revenue in the current period compared with the prior-year period. Revenue from the company's enterprise-class software and servers decreased 20.2% for the six months ended June 30, 2014 compared with the six months ended June 30, 2013. The decrease was due to lower sales of the company's ClearPath products.



Revenue from other technology decreased $2.7 million for the six months ended June 30, 2014 compared with the six months ended June 30, 2013.

Technology gross profit was 46.9% in the current six-month period compared with 53.5% in the year-ago period. Technology operating profit (loss) percent was (8.0)% in the six months ended June 30, 2014 compared with 13.6% in the six months ended June 30, 2013. The Technology segment's margins were down due to lower sales of ClearPath products. 20



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New accounting pronouncements

See note (m) of the Notes to Consolidated Financial Statements for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on the company's consolidated financial statements.

Financial condition

The company's principal sources of liquidity are cash on hand, cash from operations and its revolving credit facility, discussed below. The company and certain international subsidiaries have access to uncommitted lines of credit from various banks. The company believes that it will have adequate sources of liquidity to meet its expected near-term cash requirements.



Cash and cash equivalents at June 30, 2014 were $574.2 million compared with $639.8 million at December 31, 2013.

As of June 30, 2014, $378.8 million of cash and cash equivalents were held by the company's foreign subsidiaries. In the future, if these funds are needed for the company's operations in the U.S., the company may be required to accrue and pay taxes to repatriate these funds. During the six months ended June 30, 2014, cash provided by operations was $23.4 million compared with $30.2 million for the six months ended June 30, 2013. Cash provided by operations during the first half of 2014 was negatively impacted by an increase in cash contributions to the company's defined benefit pension plans. During the first half of 2014, the company contributed cash of $103.1 million to such plans compared with $61.3 million during the first half of 2013. The principal reason for the increase was that in the current period, the company contributed $44.0 million to its U.S. qualified defined benefit pension plan compared with $6.9 million in the prior-year period. Cash used for investing activities during the six months ended June 30, 2014 was $77.7 million compared with cash usage of $67.4 million during the six months ended June 30, 2013. Net proceeds of investments were $10.1 million for the six months ended June 30, 2014 compared with net purchases of $2.7 million in the prior-year period. Proceeds from investments and purchases of investments represent derivative financial instruments used to reduce the company's currency exposure to market risks from changes in foreign currency exchange rates. In addition, in the current period, the investment in marketable software was $40.3 million compared with $29.6 million in the year-ago period, capital additions of properties were $29.0 million in 2014 compared with $16.2 million in 2013 and capital additions of outsourcing assets were $20.1 million in 2014 compared with $18.3 million in 2013. The higher capital expenditures largely reflected increased investments in new products, as well as expenditures on automation tools and leasehold improvements that support further consolidation of the company's real estate. Cash used for financing activities during the six months ended June 30, 2014 was $15.1 million compared with cash usage of $18.2 million during the six months ended June 30, 2013. In June 2011, the company entered into a five-year secured revolving credit facility which provides for loans and letters of credit up to an aggregate amount of $150 million (with a limit on letters of credit of $100 million). Borrowing limits under the credit agreement are based upon the amount of eligible U.S. accounts receivable. At June 30, 2014, the company had no borrowings and $22.8 million of letters of credit outstanding under the facility. At June 30, 2014, availability under the facility was $78.9 million net of letters of credit issued. Borrowings under the facility will bear interest based on short-term rates. The credit agreement contains customary representations and warranties, including that there has been no material adverse change in the company's business, properties, operations or financial condition. It also contains financial covenants requiring the company to maintain a minimum fixed charge coverage ratio and, if the company's consolidated cash plus availability under the credit facility falls below $130 million, a maximum secured leverage ratio. The credit agreement allows the company to pay dividends on its preferred stock unless the company is in default 21

-------------------------------------------------------------------------------- and to, among other things, repurchase its equity, prepay other debt, incur other debt or liens, dispose of assets and make acquisitions, loans and investments, provided the company complies with certain requirements and limitations set forth in the agreement. Events of default include non-payment, failure to comply with covenants, materially incorrect representations and warranties, change of control and default under other debt aggregating at least $50 million. The credit facility is guaranteed by Unisys Holding Corporation, Unisys NPL, Inc., Unisys AP Investment Company I and any future material domestic subsidiaries. The facility is secured by the assets of Unisys Corporation and the subsidiary guarantors, other than certain excluded assets. The company may elect to prepay or terminate the credit facility without penalty. At June 30, 2014, the company has met all covenants and conditions under its various lending and funding agreements. The company expects to continue to meet these covenants and conditions. In 2014, the company expects to make cash contributions to its worldwide defined benefit pension plans of approximately $235 million, which is comprised of $109 million primarily for non-U.S. defined benefit pension plans and $126 million for the company's U.S. qualified defined benefit pension plan.



The company has on file with the Securities and Exchange Commission an effective registration statement, expiring in June of 2015, covering debt or equity securities, which enables the company to be prepared for future market opportunities.

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.

On December 10, 2012, the company announced that its Board of Directors had authorized the company to purchase up to an aggregate of $50 million of the company's common stock and mandatory convertible preferred stock through December 31, 2014. During the six months ended June 30, 2014, the company repurchased an aggregate of 552,806 shares of common stock for approximately $14.0 million. Actual cash disbursements for repurchased shares may differ if the settlement dates for shares repurchased occurs after the end of the quarter. At June 30, 2014, there remained approximately $24.3 million available for future repurchases under the Board authorization. On March 1, 2014, all of the outstanding shares of 6.25% mandatory convertible preferred stock (2,587,400 shares) were automatically converted (in accordance with its terms) into 6,912,756 shares of the company's common stock. Because March 1, 2014 was not a business day, the mandatory conversion was effected on Monday, March 3, 2014. Annualized cash dividends on such preferred stock were approximately $16.2 million.



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. 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.



Factors that could affect future results include the following:

The company's future results will depend upon its ability to effectively anticipate and respond to volatility and rapid technological change in its industry. 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, services and software on a timely and cost-effective basis 22

-------------------------------------------------------------------------------- using new delivery models such as cloud computing. 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. Future results will depend 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 on the level of demand for systems integration projects and the portfolio of solutions the company offers for specific industries. It will also depend on an efficient utilization of services delivery personnel. In addition, profit margins in this business are a function of both the portfolio of solutions sold in a given period and the rates the company is able to charge for services and the chargeability of its professionals. If the company is unable to attain sufficient rates and chargeability for its professionals, profit margins will be adversely affected. 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 headcount. The company's future results will depend on its ability to profitably grow its outsourcing business. The company's outsourcing contracts are multiyear engagements under which the company takes over management and support of a client's data center operations, end user devices, business processes or applications. System development activity on outsourcing contracts may require the company to make upfront investments. The company will need to have available sufficient financial resources in order to make these investments. Outsourcing contracts can be highly complex and can involve the design, development, implementation and operation of new solutions and the transitioning of clients from their existing processes to the new environment. Future results will depend on the company's ability to effectively and timely complete these implementations and transitions. Future results will also depend on the company's ability to maintain and grow its technology business. The company continues to invest in developing new high-end enterprise server products, cybersecurity software, cloud-based products and other offerings to meet client needs. Future results will depend on the company's ability to effectively market and sell these new products while maintaining its installed base for ClearPath and developing next-generation ClearPath products. The company faces aggressive competition in the information services and technology marketplace, which could lead to reduced demand for the company's products and services and could have an adverse effect on the company's 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 lead to reduced demand for the company's products and services and 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's future results will depend on its ability to retain significant clients. The company has a number of significant long-term contracts with clients, including governmental entities, and its future success will depend, in part, on retaining its relationships with these clients. The company could lose clients for such reasons as contract expiration, conversion to a competing service provider, disputes with clients or a decision to in-source services, including for contracts with governmental entities as part of the rebid process. The company could also lose clients as a result of their merger, acquisition or business failure. The company may not be able to replace the revenue and earnings from any such lost client. 23 -------------------------------------------------------------------------------- The company's contracts may not be as profitable as expected or provide the expected level of revenues. In a number of the company's long-term contracts for infrastructure services, outsourcing, help desk and similar services, the company's revenue is based on the volume of products and services provided. As a result, revenue levels anticipated at the contract's inception are not guaranteed. In addition, some of these contracts may permit termination at the customer's discretion before the end of the contract's term or may permit termination or impose other penalties if the company does not meet the performance levels specified in the contracts. The company's contracts with governmental entities are subject to the availability of appropriated funds. These contracts also contain provisions allowing the governmental entity to terminate the contract at the governmental entity's discretion before the end of the contract's term. In addition, if the company's performance is unacceptable to the customer under a government contract, the government retains the right to pursue remedies under the affected contract, which remedies could include termination. Certain of the company's outsourcing agreements require that the company's prices be benchmarked if the customer requests it and provide that those prices may be adjusted downward if the pricing for similar services in the market has changed. As a result, revenues anticipated at the beginning of the terms of these contracts may decline in the future. Some of the company's systems integration contracts are fixed-price contracts under which the company assumes the risk for delivery of the contracted services and products at an agreed-upon fixed price. Should the company experience problems in performing fixed-price contracts on a profitable basis, adjustments to the estimated cost to complete may be required. Future results will depend on the company's ability to perform these services contracts profitably. The company may face damage to its reputation or legal liability if its clients are not satisfied with its services or products. 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. Allegations by private litigants or regulators of improper conduct, as well as negative publicity and press speculation about the company, whatever the outcome and whether or not valid, may harm its reputation. In addition to harm to reputation, 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. Future results will depend in part on the performance and capabilities of third parties with whom the company has commercial relationships. The company maintains business 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, which can affect the company's capacity to effectively and efficiently serve current and potential customers and end users. The company's future results will depend in part on its ability to attract, motivate and retain experienced and knowledgeable personnel in key positions. The success of the company's business is dependent upon its ability to employ and train individuals with the requisite knowledge, skills and experience to execute the company's business model and achieve its business objectives. The company has significant pension obligations and may be required to make additional significant cash contributions to its defined benefit pension plans. The company has unfunded obligations under its U.S. and non-U.S. defined benefit pension plans. In 2013, the company made cash contributions of $147.2 million to its worldwide defined benefit pension plans. Based on current legislation, recent interest rates and expected returns, in 2014 the company estimates that it will make cash contributions to its worldwide defined benefit pension plans of approximately $235 million, which is comprised of $126 million for the company's U.S. qualified defined benefit pension plan and $109 million primarily for non-U.S. defined benefit pension plans. Deterioration in the value of the company's worldwide defined benefit pension plan assets, as well as discount rate changes, could require the company to make larger cash contributions to its defined benefit pension plans in the future. In 24

-------------------------------------------------------------------------------- addition, the funding of plan deficits over a shorter period of time than currently anticipated could result in making cash contributions to these plans on a more accelerated basis. Either of these events would reduce the cash available for working capital and other corporate uses and may have an adverse impact on the company's operations, financial condition and liquidity. The company's future results will depend on its ability to continue to simplify its operations and provide services more cost efficiently. Over the past several years, the company has implemented significant cost-reduction measures and continues to focus on measures intended to further improve cost efficiency. Future results will depend on the success of these efforts as well as on the company's continued ability to focus its global resources and simplify its business structure. The company's business can be adversely affected by global economic conditions, acts of war, terrorism or natural disasters. The company's financial results have been impacted by the global economic slowdown in recent years. If economic conditions worsen, the company could see reductions in demand and increased pressure on revenue and profit margins. The company could also see a further consolidation of clients, which could also result in a decrease in demand. 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 the company's business. The company's contracts with U.S. governmental agencies may subject the company to audits, criminal penalties, sanctions and other expenses and fines. The company frequently enters into contracts with governmental entities. U.S. government agencies, including the Defense Contract Audit Agency and the Department of Labor, routinely audit government contractors. These agencies review a contractor's performance under its contracts, cost structure and compliance with applicable laws, regulations and standards. The U.S. government also may review the adequacy of, and a contractor's compliance with contract terms and conditions, its systems and policies, including the contractor's purchasing, property, estimating, billing, accounting, compensation and management information systems. Any costs found to be overcharged or improperly allocated to a specific contract or any amounts improperly billed or charged for products or services will be subject to reimbursement to the government. In addition, government contractors, such as the company, are required to disclose credible evidence of certain violations of law and contract overpayments to the federal government. If the company is found to have participated in improper or illegal activities, the company may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the U.S. government. Any negative publicity related to such contracts, regardless of the accuracy of such publicity, may adversely affect the company's business or reputation. Breaches of data security could expose the company to legal liability and could harm the company's business and reputation. The company's business includes managing, processing, storing and transmitting proprietary and confidential data, including personal information, within the company's own IT systems and those that the company designs, develops, hosts or manages for clients. Breaches of data security involving these systems by hackers, other third parties or the company's employees, despite established security controls with respect to this data, could result in the loss of data or the unauthorized disclosure or misuse of confidential information of the company, its clients, or others. This could result in litigation and legal liability for the company, lead to the loss of existing or potential clients, adversely affect the market's perception of the security and reliability of the company's products and services and lead to shutdowns or disruptions of the company's IT systems. In addition, such breaches could subject the company to fines and penalties for violations of data privacy laws. This may negatively impact the company's reputation and financial results. More than half of the company's revenue is derived from operations outside of the United States, and the company is subject to the risks of doing business internationally. More than half of the company's total revenue is derived from international operations. The risks of doing business internationally include foreign currency exchange rate fluctuations, currency restrictions and devaluations, changes in political or economic conditions, trade protection measures, import or export licensing requirements, multiple and possibly overlapping and conflicting tax laws, new tax legislation, weaker intellectual property protections in some jurisdictions and additional legal and regulatory compliance requirements applicable to businesses that operate internationally, including the Foreign Corrupt Practices Act and non-U.S. laws and regulations. 25



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Financial market conditions may inhibit the company's ability to access capital and credit markets to address its liquidity needs. Financial market conditions may impact the company's ability to borrow, to refinance its outstanding debt, or to utilize surety bonds, letters of credit, foreign exchange derivatives and other financial instruments the company uses to conduct its business. Although the company primarily uses cash on hand to address its liquidity needs, its ability to do so assumes that its operations will continue to generate sufficient cash. The company's services or products may infringe upon the intellectual property rights of others. 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. Pending litigation could affect the company's results of operations or cash flow. There are various lawsuits, claims, investigations and proceedings that have been brought or asserted against the company, which arise in the ordinary course of business, including actions with respect to commercial and government contracts, labor and employment, employee benefits, environmental matters, intellectual property and non-income tax and employment compensation in Brazil. See Note (h) of the Notes to Consolidated Financial Statements for more information on litigation. The company believes that it has valid defenses with respect to legal matters pending against it. Litigation is inherently unpredictable, however, and it is possible that the company's results of operations or cash flow could be materially affected in any particular period by the resolution of one or more of the legal matters pending against it. The company could face business and financial risk in implementing future dispositions or acquisitions. As part of the company's business strategy, it may from time to time consider disposing of existing technologies, products and businesses that may no longer be in alignment with its strategic direction, including transactions of a material size, or acquiring complementary technologies, products and businesses. Potential risks with respect to dispositions include difficulty finding buyers or alternative exit strategies on acceptable terms in a timely manner; potential loss of employees or clients; dispositions at unfavorable prices or on unfavorable terms, including relating to retained liabilities; and post-closing indemnity claims. Any acquisitions may result in the incurrence of substantial additional indebtedness or contingent liabilities. Acquisitions could also result in potentially dilutive issuances of equity securities and an increase in amortization expenses related to intangible assets. Additional potential risks associated with acquisitions include integration difficulties; difficulties in maintaining or enhancing the profitability of any acquired business; risks of entering markets in which the company has no or limited prior experience; potential loss of employees or failure to maintain or renew any contracts of any acquired business; and expenses of any undiscovered or potential liabilities of the acquired product or business, including relating to employee benefits contribution obligations or environmental requirements. Further, with respect to both dispositions and acquisitions, management's attention could be diverted from other business concerns. Adverse credit conditions could also affect the company's ability to consummate dispositions or acquisitions. The risks associated with dispositions and acquisitions could have a material adverse effect upon the company's business, financial condition and results of operations. There can be no assurance that the company will be successful in consummating future dispositions or acquisitions on favorable terms or at all.


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Source: Edgar Glimpses


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