Unisys Corporation (UIS) Management Discusses Q2 2013 Results - Earnings Call Transcript

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Unisys (NYSE:UIS)

Q2 2013 Earnings Call

July 23, 2013 5:30 pm ET


Niels Christensen

J. Edward Coleman - Chairman, Chief Executive Officer and Member of Finance Committee

Janet Brutschea Haugen - Chief Financial Officer and Senior Vice President


Ned Davis - Wm Smith & Co.

James E. Friedman - Susquehanna Financial Group, LLLP, Research Division

William S. Smith - Wm Smith Securities, Inc.

Paul Wehner - DLS Capital Management


Good day, and welcome to the Unisys Second Quarter 2013 Results Conference Call. At this time, I would like to turn the conference over to Mr. Neils Christensen, Vice President of Investor Relations at Unisys Corporation. Please go ahead, sir.

Niels Christensen

Thank you, operator. Good afternoon, everyone, and thank you for joining us. Earlier today, Unisys released its second quarter 2013 financial results. With us this afternoon to discuss our results are Ed Coleman, our CEO; and Janet Haugen, our CFO.

Before we begin, I want to cover a few housekeeping details. First, today's conference call and the Q&A session are being webcast via the Unisys investor website. Second, you can find the earnings press release and the presentation slides that we will be using this afternoon to guide our discussion on our investor website. Third, today's presentation, which is complementary to the earnings press release, includes some non-GAAP financial measures. These have been provided in an effort to give investors additional information. The non-GAAP measures have been reconciled to the related GAAP measures and we provided reconciliations charts at the end of the presentation.

Finally, I'd like to remind you that all forward-looking statements made during this conference call are subject to various risks and uncertainties that could cause actual results to differ materially from expectations. These factors are discussed more fully in the earnings release and in the company's SEC filings. Copies of these SEC reports are available from the SEC and from the Unisys investor website.

Now I'd like to turn the call over to Ed.

J. Edward Coleman

Great. Thanks, Niels. Hello, everyone. Thank you for joining us today to discuss our second quarter 2013 financial results. Please turn to Slide 4 for an overview of our performance in the quarter. After a difficult start to the year in the first quarter, Unisys reported a sequentially improved and profitable second quarter in what continues to be a challenging IT spending environment.

We reported diluted earnings per share of $0.46 in the quarter compared with diluted EPS of $0.99 in the second quarter of 2012. Excluding pension expense in both periods, as well as a small debt reduction charge in the year ago quarter, our non-GAAP EPS was $0.91 in the current quarter compared with $1.41 a year ago.

Our technology business had a strong second quarter, growing revenue 13% on higher sales of our ClearPath enterprise software and servers. Year-to-date, our ClearPath revenue is up 3%. As we've said in the past, this business is best measured on an annual basis, and we remain focused on our goal of stable annual technology revenue.

Our primary challenge from a business perspective continues to be in our services business. Our services revenue declined 9% in the quarter, driven primarily by revenue declines in both systems integration and outsourcing services. The lower revenue impacted our services' operating margins, which came in at 4% for the quarter, up sequentially but below our 8% to 10% target.

We were encouraged by some improvement in our U.S. Federal revenue from the declines that we were seeing in previous quarters. Total revenue in U.S. Federal declined 2% in the quarter and was up 4% sequentially. The year-over-year revenue decline was due to lower technology sales. Federal services revenue was flat with a year ago.

During the quarter, we won a number of key U.S. Federal government contracts, including renewals and new projects, with the Department of Justice, the Department of the Interior and the Federal Deposit and Insurance Corporation.

Last week, we were also informed that we were awarded a major new single award IDIQ contract from the Department of Homeland Security to provide full lifecycle services to customs and border protection in support of its border enforcement and management systems. This award, which represents new work and expands on our existing relationship with customs and border protection, is for 5 years with a 1-year base contract and 4 1-year options and a total ceiling value of up to $460 million.

Turning to Slide 5. While the services market is challenging, we continue to see growth opportunities in helping organizations take advantage of disruptive technologies such as cloud, mobile computing and social computing to deliver the next generation of IT services more effectively and cost efficiently.

From government agencies to commercial enterprises, we're seeing more organizations beginning to adopt these new technologies and new IT delivery models. At the same time, many organizations are understandably concerned about the security and reliability of these new services. This is an area where Unisys, with our capabilities and leadership and secure mission-critical computing, can provide clear advantages and differentiation in the market.

In the area of cloud computing, for instance, Unisys has been in the forefront of helping U.S. government agencies, such as the General Services Administration, the National Oceanic and Atmospheric Administration, the Department of Energy's Idaho National Labs and the U.S. National Archives move to secure cloud-based e-mail systems based on Google apps for government.

We also recently won new business from the U.S. Department of Interior, a new client, to move its mission-critical financial and business management ERP system to the cloud. In addition to this cloud computing integration work, we are offering a growing number of industry vertical and cross-industry software solutions via a cloud base as a service model, enabling us to open up our offerings to a larger market.

Last quarter, for instance, I spoke about our cloud-based air cargo solution, which continues to attract new airline clients from the engine cargo shipments through an easy-to-use web portal.

As another example, in the United Kingdom, much of that country's mortgage processing volume runs on the Unisys financial services system solution. To address a larger share of that market, we're now offering our UFSS solution via software-as-a-service model, and we've already received a contract to move several new financial services clients to our software-as-a-service offering.

In the coming weeks, we also plan to introduce a software-as-a-service version of our InfoImage Enterprise Content Management software, which is used by clients in high-volume document processing environments, most notably in public sector and financial services organizations.

And a key element of our IT outsourcing business is providing IT service management software-as-a-service. Our ITSM as a service solution is now used by more than 140 clients who rely on this cloud-based solution for the management of IT services throughout their organizations.

Turning to Slide 6. As we look to the second half of the year and beyond, in addition to continued investments in our existing solutions for security, data center, end-user outsourcing and application modernization, as I noted in our last call, we're making additional investments in new areas to drive growth. These investments are in our Stealth Solution Suite of cybersecurity products and our reseller channel program and application managed services and within our technology business and our Intel-based enterprise server program.

Let me touch on each of these briefly. Regarding our Stealth cybersecurity solutions, we continue to be excited by the growth potential for these software products. Organizations around the world are searching for better, more cost-effective ways to protect against sophisticated cyber attacks, recognizing that the traditional security approaches, such as perimeter defense and endpoint protection, aren't meeting the challenge.

Our Stealth Solutions take a radically different approach, utilizing advanced cloaking techniques to allow clients' most important assets, be they applications, databases, end-users or user communities, to go dark on the network, rendering them effectively invisible and providing protection from internal and external threats.

During the second quarter, we announced the availability of our Stealth Solution Suite on Amazon web services, enabling organizations to gain these advanced network security capabilities when moving their workloads to the Amazon cloud. As with any disruptive technology, it takes time to educate the market on the new solution and drive sales among early adopters, but we're encouraged by the growing interest we're seeing in Stealth.

Stealth is also the first of our software solutions that we're offering through our new channel program. As I mentioned in the past, Unisys currently gets a minimal amount of revenue through resellers and distributors relative to our major competitors, and we're looking to change that by creating a vibrant channel program.

In recent months, we've been steadily building out our partner network. And today, we've brought on 40 value-added resellers in North America and Europe, as well as a European distributor. These VARs represent an important new sales channel to help us expand our market reach for our Stealth products, as well as for other future offerings.

A lot of work is being done right now to train and educate these VARs on Stealth and increase their mind share with Unisys. And while we're in the early stages of our channel program, we're pleased with the progress we're making.

In addition to stealth and our channel program, we're also focused on driving growth in application managed services, which complements other elements of our IT outsourcing services portfolio. The application managed services market is growing, as organizations increasingly look to outsource the management of their applications to reduce cost and improve service to their end-users. Unisys offers a number of advantages in this market, including the further leveraging of our consistent idle-based global support network and our expertise in delivering a better end-user experience.

As I noted on our last call, Unisys has provided application managed services or application outsourcing for many years, but we've done this on a project-by-project basis. What is different today is that we pulled our capabilities together from around the world and organized ourselves to identify, pursue and address this market in a broader and more consistent manner. With some initial wins already and a growing pipeline, progress to date is encouraging.

Finally, in the technology area, we continue to invest in our ClearPath line of enterprise software and servers, where we believe we lead the industry in bringing mission-critical capabilities to Intel x86 technology, while drawing on these strengths and capabilities to enter new markets with new products.

Later this year, we plan to introduce a new line of high-end server products that take Intel x86-based technology to new levels of mission-critical performance, giving organizations more secure cost-effective options for consolidating their server environments, migrating off expensive UNIX platforms and managing workloads in cloud and virtualized IT environments.

In summary, we are pleased to see improved second quarter results after a tough first quarter. We were particularly pleased with the strong technology and ClearPath sales in the quarter. Our biggest challenge as a company continues to be driving profitable growth in our services business that enables us to deliver consistent services revenue growth and improved operating margins.

While the services market is challenging at the moment, we continue to see growth opportunities aligned with our strengths and we're focused on executing on our growth initiatives as we move into the second half of the year. I look forward to updating you on our progress in our next call. In the meantime, here's Janet to take you through our results in more detail, and then we'll be happy to take your questions.

Janet Brutschea Haugen

Thanks, Ed, and hello, everyone. Let me start with our overall second quarter 2013 financial results. Please turn to Slide 8. At the top line, we reported revenue of $859 million in the quarter, which was down 7% year-over-year, but up 6% from the first quarter. After a soft first quarter, our technology revenue grew 13% year-over-year in the second quarter fueled by increased ClearPath sales. ClearPath revenue was up 18% for the quarter and 3% for the first half. Services revenue declined 9% year-over-year but recovered modestly from the first quarter, growing 2% sequentially, largely due to improved levels of project work.

Currency had a minimal negative impact on our overall revenue in the quarter. Based on today's rates, we anticipate currency to have a 1 percentage point negative impact on revenue in the third quarter of 2013 compared to the third quarter of 2012.

As a result of the lower year-over-year volume in our services segment, as well as the mix of our technology revenue, our gross profit margin declined from 26.4% in the second quarter of 2012 to 23.4% in the second quarter of 2013.

Operating expenses fell by 1% year-over-year in the second quarter of 2013. Our operating expense reductions in the quarter more than offset the incremental investments we continue to make in our key growth initiatives, as well as some additional cost reduction actions taken during the second quarter to lower the company's overhead.

Interest expense decreased by about 2/3 from $7.9 million in the second quarter of 2012 to $2.6 million in the second quarter of 2013, reflecting the impact of our debt reductions and the refinancing in the third quarter of 2012.

Other income expense for the second quarter of 2013 was $14.1 million of other income, principally attributable to foreign exchange gains. This compares to $4.1 million of other income in the year ago quarter, which was also primarily related to foreign exchange gains.

Second quarter 2013 pension expense was $22.8 million compared to $21.1 million in the second quarter of 2012. Within the income statement, pension expense is allocated to cost of revenue, SG&A and R&D on the same basis as the salaries of active employees. Pension expense is not included in segment results. We expect approximately $91 million in pension expense in 2013 compared with pension expense of about $108 million in 2012.

At the tax line, we had a $22.7 million tax provision in the quarter on pretax income of $49.5 million compared with a $22.1 million tax provision in the year ago quarter on pretax income of $75.2 million. As I have said previously, our effective tax rate varies significantly quarter to quarter based on the geographic distribution of our income, and we saw that variation in this quarter.

The passage of the U.K. Finance Act of 2013 earlier this month will reduce the U.K. corporate tax rate to 21% effective April 1, 2014, and to 20% effective April 1, 2015. These rate reductions reduce the future value of our U.K. net deferred tax assets and are expected to increase our third quarter 2013 income tax provision by approximately $11.7 million. We saw similar impacts to our income tax provisions when the U.K. rate reductions happened in both 2011 and 2012.

We reported net income of $20.4 million in the second quarter versus net income of $46.6 million in the year ago quarter. Excluding the impact of pension expense in both years and a debt reduction charge in the second quarter of 2012, we reported non-GAAP net income of $42.3 million for the second quarter 2013 compared to non-GAAP net income of $68.4 million in the prior year period.

Our second quarter 2013 diluted earnings per common share was $0.46 compared to $0.99 in the year ago quarter. Excluding the impact of last year's debt reduction charge and pension expense in both quarters, our second quarter 2013 non-GAAP diluted EPS was $0.91 compared to $1.41 in the second quarter of 2012.

Moving on to discuss our second quarter revenue in more detail, please turn to Slide 9. As noted earlier, services revenue, which represented about 86% of our revenue in the second quarter of 2013, declined 9% year-over-year. Currency had a 1 percentage point negative impact on services revenue comparisons in the quarter.

Technology revenue, which accounted for 14% of our total revenue, rose 13% year-over-year, 8% on a constant-currency basis.

On Slide 10, you can see our overall services margin and our services revenue by portfolio. Year-over-year, IT outsourcing revenue declined 12% in the second quarter of 2013 from a challenging compare in 2012, particularly within public sector in North America and Australia. Systems integration was 11% lower in the second quarter of 2013 than in the prior year, reflecting reduced project volume in Europe and Asia.

Services gross profit margin decreased 280 basis points year-over-year to 18.2% from 21% in the second quarter of 2012. This decrease was largely due to lower revenue. The services operating margin declined 400 Basis points year-over-year to 4% in the second quarter of 2013.

Despite the year-over-year decline, I do want to point out that we have seen sequential improvement from the first quarter 2013 services gross margin and operating margin. We still have work to do to get to our goal of 8% to 10% services operating margins. Achieving the goal requires improved execution, including revenue growth from our focused services areas and some improvement in our U.S. Federal business, as well as continued improvements in the delivery of our services through increased automation and efficient labor utilization.

In addition, revenue growth would enable us to better leverage our operating expenses and would contribute to improved operating margins in our services business.

Moving on to technology revenue and margins on Slide 11. Enterprise Class Software and Servers revenue increased 11% year-over-year, largely due to the strength in our ClearPath business. Sales of other technology, all of which is third-party product, rose by about $2 million.

As we have said previously, the technology business is best measured on an annual basis, and our goal remains keeping annual technology revenue stable. While technology revenue grew in the second quarter, the gross margin of 59.4% in the second quarter of 2013 was 400 basis points lower than the comparable period in 2012. Our technology operating margin declined from 28.6% a year ago to 23.9%.

Slide 12 shows our second quarter revenue by geography and industry. Our North American revenue, which represented 41% of revenue in the quarter, declined 6% with ITO driving most of that decline. Revenue from the U.S. Federal government represented 14% of total Unisys revenue in the second quarter.

International revenue declined 7% in the quarter and was down 6% on a constant currency basis. Revenue in our European region was down 10% in the second quarter on an as-reported basis and declined 9% in constant currency. This decrease was principally related to a decrease in systems integration revenue.

The Asia Pacific revenue decreased by 20% on both an as-reported and constant-currency basis. This decline largely reflected lower public spending in Australia and lower systems integration revenue in Asia.

Our Latin America region performed well, with revenue growth of 22% on an as-reported basis and 27% in constant currency. The growth was driven principally by higher technology revenue and increased ITO volume.

From an industry perspective, public sector, which reported a 6% year-over-year decline in revenue, remained our largest single industry revenue source, representing 41% of total revenue. This decline was largely attributable to reductions in Australia.

Revenue from commercial industry customers represented 35% of our second quarter revenue, while the financial sector was 24%. Both did decline in the quarter. The decline in commercial revenue was primarily attributable to lower systems integration revenue.

Moving on to Slide 13, which provides more detail on our U.S. Federal government revenue over the past 6 quarters. In the second quarter of 2013, revenue from civilian agencies represented about 46% of our U.S. Federal government revenue. Revenues from Homeland Security agencies represented about 28% of our overall U.S. Federal government revenue, while the U.S. Department of Defense and various intelligence agencies represented about 26% of our overall U.S. Federal government revenue.

Compared to the year ago quarter, our U.S. Federal revenue declined approximately 2% to $119 million, a significantly slower rate of decline than we have seen in recent quarters. We were pleased to see that the revenue increased by 4% sequentially. And further, as Ed noted, we won a number of significant contracts during the second quarter and start the third quarter with a new business win with Customs and Border Protection.

We ended the second quarter of 2013 with about $259 million of U.S. Federal services backlog, which was down 11% versus the second quarter of 2012. The U.S. Federal environment remains challenging. We expect continued procurement process delays that are often extended by award protest. Pricing pressures remain significant and competition is aggressive. However, we believe we have made some important changes in our cost structure and strategic approach that should position us well going forward.

For some comments on services orders, please turn to Slide 14. In the second quarter, our services orders rose slightly year-over-year with growth in systems integration orders. From a geographic perspective, we saw year-over-year services orders growth in our North American and Latin American regions during the second quarter.

Orders in our European and Asia Pacific regions declined in comparison to the second quarter of 2012.

We ended the second quarter with $4.8 billion in services backlog versus $5.1 billion at June 30, 2012. The decline principally reflected reductions in our ITO and BPO backlog. Of the $4.8 billion in services backlog at June 30, 2013, approximately $645 million is anticipated to convert into third quarter 2013 services revenue.

During the past 10 quarters, the amount of revenue and backlog at the start of the quarter has ranged between 85% and 90% of our quarterly services revenue for the full quarter and the sell-and-bill revenue has accounted for the remainder.

Moving to cash, please turn to Slide 15 for an overview of our cash flow performance in the quarter. We generated $16.1 million of cash from operations in the second quarter of 2013 compared to $57.1 million in the year ago quarter. We contributed $34.7 million in cash to our defined benefit pension plans in the second quarter of 2013 versus $50.6 million in the second quarter of 2012. The pension funding contributions are reflected in the cash flow from operations.

Excluding the impact of the debt reduction charge in the second quarter of 2012 and pension expense in both periods, Unisys generated adjusted EBITDA of $112.6 million in the second quarter of 2013 versus $148.6 million in the prior year period.

Capital expenditures were $38.2 million in the second quarter of 2013 versus $34.8 million in the second quarter of 2012. We expect full year capital expenditures of about $150 million.

We had free cash flow usage of $22.1 million in the second quarter of 2013 versus free cash flow generation of $22.3 million for the same period last year.

Our free cash flow generation before the pension cash contribution was $12.6 million for the second quarter of 2013 versus $72.9 million in the second quarter of '12.

Depreciation and amortization was $40 million in the quarter, down from $46.5 million in the second quarter of 2012.

Our debt balance was $210 million at June 30, 2013, down from $292 million at June 30, 2012, as a result of the debt reduction actions completed during the third quarter of 2012.

Our cash balance of $576 million at June 30, 2013, was almost 3x our debt, and our net cash position remains stable versus the prior year at $366 million.

As we have previously discussed, in December 2012, our Board of Directors authorized the purchase of up to $50 million of the company's common and preferred stock through December 2014. We repurchased approximately 612,000 shares of common stock for $11.5 million in the second quarter. There is $38.5 million remaining under the board authorization.

I would like to take a moment to provide some information regarding our defined benefit plan. First, let me start with discount rates, which are used to present value pension obligations under U.S. GAAP. These rates are set annually and for us, set at December 31. The discount rate used to present value the U.S. benefit plan obligations was 4.01% at December 31, 2012. For the international plan, the weighted average discount rate was 3.92% at December 31, 2012. As we noted during our 2012 year-end earnings release call, a 25 basis point change in the discount rate would change the U.S. obligations by approximately $140 million and the international obligations by $122 million.

Historically, our pension underfunding on a U.S. GAAP basis has been significantly impacted by the change in discount rate. Since December 31, 2008, the discount rate for U.S. obligations has declined from 6.75% to 4.01%, a 275 basis point reduction.

Internationally, the weighted average discount rate has moved from 6.42% at December 31, 2008, to 3.92% at year-end 2012, a 250 basis point reduction. These reductions in the discount rates have significantly contributed to the increase in our pension liabilities, which grew from approximately $6.3 billion at December 31, 2008, to approximately $8.6 billion at December 31, 2012.

The vast majority of the underfunded plan are closed and/or frozen as reflected in our current year service cost within pension expense of approximately $10 million on an annualized basis.

On Slide 16, we show the impact on our pension liabilities if the discount rate was changed to reflect the interest rate conditions at June 30, 2013. For this estimate, we held all other assumptions constant with those used at December 31, 2012. And of course, our 2013 pension obligations will be calculated using discount rates and other assumptions at December 31, 2013.

If we were to reset the discount rate to June 30, 2013 market conditions, the U.S. rate increases from 4.01% at December 31, 2012, to 4.83%. The weighted average international rate increases from 3.92% at December 31, 2012, to 4.15%. This would result in an approximate $600 million reduction in our reported pension liability.

Assets have remained stable since December 31, 2012, as positive asset returns during the first half of 2013 have been offset by benefit payments and currency impact.

With respect to cash funding requirements, we have also provided a schedule on Slide 17 that outlines the anticipated funding requirements over the next 13 years based on assumptions consistent with those made at December 31, 2012. There is no significant change in the funding through 2017 from what we provided in conjunction with our year-end results, but we thought it would be helpful to illustrate payment out through the point where the U.S. funding requirements will return to 0.

The future funding requirements are likely to change based on, among other factors, market conditions and future public IRS discount rates. Future contributions to international plans will be based on local funding regulations and agreements and are likely to change in 2014 and beyond based on a number of factors, including market conditions, changes in discount rates and changes in currency.

As you can see, we've expanded our pension disclosures. I do want to note that these numbers will likely change over time as market rates, asset returns, regulatory environment and other assumptions may change. However, we wanted to provide you an estimate based on the June 30, 2013, environment.

Let me conclude by saying that as we move through 2013, we are focused on improving our services revenue and margins, and we'll continue our efforts to drive top line growth and profitability.

Thank you for your time. And now, I'd like to turn the call back over to Ed.

J. Edward Coleman

Thanks, Janet, very much. Operator, if we may, let's open the lines up for questions.

Question-and-Answer Session


[Operator Instructions] We'll go first to Ned Davis with William Smith & Co.

Ned Davis - Wm Smith & Co.

I'd like to get a little more clarification on the estimated future pension cash contributions. So the chart that's on Slide 17, that does not reflect the June 30 $600 million potential adjustment at all? Or does it?

Janet Brutschea Haugen

It does not. Ned, it does not. The funding requirements -- let me back up. The discount rate that's used on Slide 16 is the U.S. GAAP discount rate. The funding requirements that are shown on Slide 17 are a function of the regulatory or other -- predominantly, the regulatory environment that sets different rates from the discount rate. So on Slide 16, we have updated that for the discount rate environment at June 30 and the estimated future pension cash requirements on 17 are based on the December 31, 2012, rate as they existed.

Ned Davis - Wm Smith & Co.

Okay. But my question is, I know you can't estimate exactly what the IRS rate would be or exactly how it will be adjusted, but assuming just that the change in rate since December 31 were to remain in effect at the end of the year, when you did your projection for actual cash contributions at the end of 2013, the number would -- the total of these payments would drop. It's just the timing is a little bit uncertain. Is that a correct assumption?

Janet Brutschea Haugen

It will depend. The U.S. funding requirements are set by the PPA rate. And as we've discussed before, include looking at both current rate and a 25-year average. So those rates are -- do not move the same direction or as quickly as you would see in the discount rate used for U.S. GAAP.

Ned Davis - Wm Smith & Co.

Okay. Can I just switch over to ClearPath quickly? The -- it was encouraging to see such an excellent quarter. I'm wondering, with the new server that you're introducing later in the year, are you gaining momentum with new customers? And is there any kind of increment with new customers that you haven't been experiencing the last few years? Is there some acceleration of opportunity with new customers, particularly around the Stealth and all those others -- I'm sorry, yes?

J. Edward Coleman

Yes. Thanks, Ned. I mean there's -- in any given year, there's a few new customers that come over to the ClearPath platform. Predominantly, the growth in ClearPath capacity in the marketplace has really stemmed from the growth of existing customers' use of ClearPath, either for the traditional workload or as we've opened a platform up, in some cases, moving some additional new workloads over to those existing installations. What we think is exciting about the platform that we intend to announce later this year is it opens -- in our view, it opens us up to the opportunity to pursue fundamentally new markets for our technology, mission-critical computing, running on Intel x86 technology to reach new customers in new markets.


We'll go next to Joey Yang with Susquehanna.

James E. Friedman - Susquehanna Financial Group, LLLP, Research Division

It's actually Jamie Friedman with Susquehanna. I want to ask a couple of questions. First, on the federal business, I know you touched on this briefly, but I think you may have modestly understated the magnitude. I wanted to see if you could share a little bit more about the Custom and Border Protection assignment, which you guys press released, but it was also press released on the Custom and Border Protection website. And if you can give us a sense, Ed, of the magnitude of this? Was it in your backlog? It is, I believe, an IDIQ, and when you would expect to start billing for something of this magnitude?

J. Edward Coleman

So as we've said, it's new work for us. Customs and Border Protection has been a good client of ours for a number of years. We've had an award-winning program. The land border initiative with them, which has been more of a front office support for their mission at the border crossings, this is really new work for us supporting their back office, more their back office systems. So it's new work. It's one that we've been working on for quite a while. We're very excited about having been awarded it. It's not been in our backlog. It's been in our pipeline but not in our backlog, and the ramp-up of the revenue and the degree to which it hits our backlog, our order backlog, will really depend on the funding that occurs for the individual task orders that will be issued on the contract.

James E. Friedman - Susquehanna Financial Group, LLLP, Research Division

Okay, that was going to be my follow-up, whether it was funded or unfunded. So I don't know if this is from your press release or from their press release, but there was a public disclosure of $460 million of ceiling volume. Is that accurate?

J. Edward Coleman

That's correct. It's a single source award of an IDIQ, indefinite delivery, indefinite quantity, which means task orders are going to be issued against this contract. And so the ceiling value of the whole contract over 5 years, which is 1 base year and 4 optional years is the $460 million.

James E. Friedman - Susquehanna Financial Group, LLLP, Research Division

Okay. And then just stepping back, Ed, with regard to services margins, and it was otherwise a tremendous quarter, it was a tremendous quarter in all respects. When, though, do you think that we can return to the target margin objectives in services? And at least as importantly, how do we get there of 8% long term?

J. Edward Coleman

Yes, I think it's really dependent -- as Janet said in her comments, one, we've got to get revenue growth going in IT outsourcing and systems integration. And we're certainly looking to, in the second half of this year, to begin to move up as opposed to moving down in IT outsourcing and systems integration. And also, I think, as Janet noted, we need to get that continued improvement in the federal business. That's a large part of our systems integration business. We need to see the continued progress there. Very happy about what we saw this quarter with the new wins in the second quarter and certainly kicking off the third quarter with the BIMS contract, or the BIMS award. But in addition to the revenue side of things, we have to keep looking at ways to make our service delivery more efficient. I have a portfolio of services that's more leverageable, that's less dependent on adding labor as you add services revenue and continued, as we always do, a focus on reducing our overhead to be as efficient as we can possibly be. But the real crux of it is we are fully engaged on the issue of revenue growth in systems integration and IT outsourcing, and we need to drive that across our business.

James E. Friedman - Susquehanna Financial Group, LLLP, Research Division

Last question, I don't want to monopolize the time, but could you comment on the linearity of the quarter? Was it ratable, April, May, June? Was it front- or back-end loaded? If you can comment on the timing of delivery in the quarter?

J. Edward Coleman

It's -- the services generally are pretty consistent and smooth across the quarter, the technology transaction is less so. It's -- as you know, it can be very spiky depending on when transactions occur. And some occur early, some occur in the middle and some occur late.


We'll take our next question from Bill Smith of William Smith & Co.

William S. Smith - Wm Smith Securities, Inc.

Ed, on the 40 VARs that you've added to your distribution network, is that all just related to Stealth? Or could some of that also be related to the ITO and the systems integration and ClearPath businesses as well?

J. Edward Coleman

At this point, it's all about Stealth. We -- again, we're doing sort of 2 innovative things or new things at one time, which is one, how do we take this disruptive technology to market and reach a broader part of the market than we can reach with our direct sales force; and two, how do we build a channel, a reseller channel, which is a different way of going to market for us. So we've really used Stealth as the product to focus on to build the channel around. Once that channel's built out, we think there's an opportunity to look at other pieces of software or other technology products that we have to take to market through a reseller channel as well, some of whom may also be the Stealth resellers or they may require a different skill set for different products. So right now, it's really laser focused in on Stealth.

William S. Smith - Wm Smith Securities, Inc.

And is 40 VARs, are -- would that be the total build out of that network or could there be more?

J. Edward Coleman

There could be more, there could be -- what we're trying to do, Bill, with Stealth, though, is make sure that we're signing up VARs that understand the security business and understand that various technologies that are available to meet cybersecurity requirements as opposed to opening it up to as many VARs as we can possibly get. We really want people who are subject matter experts in the area of security.

William S. Smith - Wm Smith Securities, Inc.

And are you seeing other opportunities in vertical markets then, or do you think you would by virtue of developing these VAR relationships?

J. Edward Coleman

Yes, I mean -- when Janet goes through our vertical orientation, we talk about public sector, commercial, financial services. As an example, we don't talk much about health care, because we don't have a strong vertical presence in health care. But that's an example where a reseller that is oriented towards the health care industry vertical could help us get broader reach of our product into a vertical that we don't normally cover with our direct sales force.

William S. Smith - Wm Smith Securities, Inc.

And when you mentioned the 40 VARs, you also mentioned plus a European distributor. Is that different? You've segregated it out, so is that different?

J. Edward Coleman

Well, the IT channels, generally, are considered to be either 1-tier or 2-tier channels. 1-tier is where the OEM, that's us, manages a reseller network, the value-added reseller network themselves. In a 2-tier channel, the OEM does business with the distributor, who, in turn, has their own network of resellers. So in the U.S. right now, we're going 1-tier. In Europe, we're doing a combination of 1-tier, as well as a 2-tier approach.


[Operator Instructions] We'll go next to Paul Wehner with DLS.

Paul Wehner - DLS Capital Management

Actually Ned, the first caller, asked my pension question verbatim, so I'll let someone else take over.


[Operator Instructions] And we have a follow-up from Ned Davis of William Smith & Co.

Ned Davis - Wm Smith & Co.

I just was wondering why is the CapEx still at $150 million, growing 15%, I think, year-over-year if revenues aren't growing anywhere near that or a negative? What's in that CapEx that keeps driving it?

Janet Brutschea Haugen

So that CapEx, the $150 million is our estimate of CapEx expenditures for the full year. I mean, it does include our investments in outsourcing. It includes our software development costs, as well as a small portion of what we use internally. As Ed mentioned, we are looking to improve our performance in moving revenue from declining to moving in the -- moving up in the second half of the year based upon the pipeline of what we see in opportunities. Right now, $150 million for CapEx is our best estimate of what we expect to be spending for the full year.


It appears there are no further questions. I'd now like to turn the conference back over to Chairman Ed Coleman for any additional or closing remarks.

J. Edward Coleman

Well, thank you, operator. Let me just close by saying thank you to everyone that was on the call this evening. And we certainly look forward to you joining us on our third quarter earnings call here in a couple of months. So thanks very much. Bye-bye.


Thank you. That does conclude our conference. You may now disconnect.

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