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Executives

J. Coleman - Chairman of the Board and Chief Executive Officer

Niels Christensen -

Janet Haugen - Chief Financial Officer and Senior Vice President

Analysts

James Friedman - Susquehanna Financial Group, LLLP

Chris McDonald - Kennedy Capital

Bill Smith - Lowering, Smith and Company

Joseph Vafi - Jefferies & Company, Inc.

Unisys (UIS) Q1 2011 Earnings Call April 25, 2011 5:30 PM ET

Operator

Good day, everyone and welcome to the Unisys First Quarter 2011 Results Conference Call. At this time, I would like to turn the conference to Mr. Niels Christensen, Vice President, 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 first quarter 2011 financial results. With us this afternoon to discuss our results are Ed Coleman, our CEO; and Janet Haugen, our CFO. Before we begin, I wanted 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. These materials are available for viewing, as well as downloading and printing. Third, today's presentation, which is complementary to the earnings press release, includes 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 have provided reconciliation 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. Coleman

Thanks, Niels. Hello, everyone and thank you for joining us today. Please turn to Slide 1 as we begin our discussion. The first quarter was a challenging one for Unisys as the results were impacted by weakness in our U.S. Federal Government business. This was our first quarter without the TSA contract, which represented about $30 million in revenue in the year-ago quarter. But we knew we had a tough hurdle coming into the quarter. In addition, we saw less-than-expected federal agency spending as a result of the government budget impasse that continued throughout the quarter. As you know, until the 2011 federal budget was finally passed a couple of weeks ago, 6 months into the fiscal year, the government was operating on a series of continuing resolutions that limited funding on new contracts. This also affected funding availability for many of our existing cost plus and time and materials contracts, which represent about half of our federal revenue. These 2 factors contributed to a $50 million decline in our federal revenue, which along with the charge related to our debt reduction activities, put pressure on our overall results and contributed to a net loss in the quarter. The focus on spending cuts and deficit reduction in Washington is creating a more challenging environment in the federal market, which represents about 20% of our revenue. Nonetheless, Unisys, with our long history in the government space, brings a great deal of innovation and experience to this market and we're focused on opportunities to help agencies cut costs and operate more effectively and securely through our outsourcing, applications modernization, security and cloud computing solutions.

While our federal results and the loss in the quarter were disappointing, we remain confident in our strategy and focus on achieving the 3 year goals we've set. In fact, as we look at our performance outside the U.S. Federal business, we saw a progress in the quarter against these goals.

As a reminder, these goals, which you can see in Slide 2, are: To increase our annual pretax profit to $350 million in 2013, excluding any change in pension income or expense from 2010 levels; to reduce our debt by 75% from the September 2010 level by the end of 2013; and to consistently achieve an 8% to 10% Services operating margin. To achieve these goals, we're focused both on growing our IT Outsourcing and systems integration services revenue at market rates, adjusted for the fact that we no longer have the TSA revenue in 2011, while maintaining flat technology revenue over the 3 year period.

As we look at progress against our goals turning to Slide 3, first during the last 60 days, we took actions that accelerated our progress toward achieving our 75% debt reduction goal. As you saw in our recent announcements, in the first quarter, we completed a mandatory convertible preferred stock offering and used the proceeds to redeem approximately $211 million of our high coupon senior secured notes. We took a charge of approximately $32 million in the quarter related to these actions. On April 11, we used cash to retire an additional $179 million of our senior secured notes. Since September 2010, we've reduced our debt by about half. These actions will enable us to reduce our annual interest expense by $53 million, an important contributor to achieving our 2013 pretax profit goal.

Second, we continued to show good cost discipline. Operating expenses were down again in the quarter and outside the federal business, we improved our Services operating margins year over year. Third, we saw a progress during the quarter against our top line goals. While our total Services revenue was down 6% in the quarter, outside the Federal business, Services revenue was flat year over year compared to the last few years of declines. And in our IT Outsourcing business, we grew our non Federal revenue by 9% in the quarter. This represents the fifth consecutive quarter of year over year growth in non Federal ITO revenue.

We're having particular success in the area of in user outsourcing, where Unisys is increasingly recognized as an industry leader. For instance, Gartner recently placed Unisys again in the Leaders Quadrant for North American Helpdesk Outsourcing Providers. We continue to add new IT Outsourcing accounts and we have a strong and growing pipeline of opportunities. In our project based systems integration business, we saw some improvement in the first quarter, following double digit revenue declines in 2010. While we have work to do to get this business to market growth, we see opportunities in this market around disruptive technology trends, particularly in helping clients build out secure private and hybrid clouds and modernize our mission critical applications to deal with the increased mobility in the use of social networking.

In our Technology business, while overall revenue was down in the quarter, we grew sales of ClearPath systems 7% in the first quarter, which followed 5% growth in ClearPath revenue for the full year of 2010. As you know, our ClearPath sales vary from quarter to quarter depending on the timing of transactions, so we believe it's best to judge this business on a full year basis. But we've clearly got 2011 off to a good start in the first quarter.

So in summary, turning to Slide 4, while this was a challenging quarter for us and we're not yet firing on all cylinders as a company, there was progress in the quarter that moves us further down the road toward our long term objectives. We recognize that our biggest challenge right now is to drive profitable revenue growth in our areas of strength that enables us to leverage the foundational work we've done to strengthen our cost structure, balance sheet and portfolio.

There's no lack of opportunity in the market. Organizations are looking for help to reduce costs and to address and harness disruptive new technologies, like mobile computing, social computing, cloud, smart computing, IT appliances and cybersecurity. To capture these growth opportunities, we're focused on improving our sales execution. We've strengthened our sales leadership, are investing in building our sales force to take our solutions to market and have changed the way we approach client planning, to increase cross selling efforts across our business units.

Across the company, I continue to be excited by the client engagements we're winning. In the U.S., we're working with the General Services Administration to move agency employees to a cloud based, Google email and collaborative computing environment. We're helping the USDA provide realtime monitoring and response to security incidents across its 29 agencies. And we're building a new child welfare system for a Midwest state.

In Latin America, we're rolling out a national citizen identification program using advanced biometric technologies for 100 million Mexican citizens. And we're using our ClearPath ePortal technology to allow customers of a major utility to pay their water bills using their smartphones. In Continental Europe, we're helping a national social security agency modernize its IT accounting applications to more cost effectively serve citizens. And we're working with a major manufacturer to standardize and enhance end user services to 48,000 employees globally.

And in Asia Pacific, we're helping China's growing aviation industry build advanced passenger processing systems for new airports. And we're helping Hertz New Zealand protect customer credit card data against fraud through the use of our stealth data protection technology.

There are more examples, but the point I'd like to leave you with is that because of the work we've done in refocusing the business, reshaping the portfolio, strengthening the balance sheet and reducing our costs, we believe that Unisys is positioned to benefit from important trends that are reshaping the IT market and creating opportunities for growth.

I'm confident we have the right strategy and we're focused on executing that plan in achieving our stated financial goals. Thanks again for joining us today. Now, I'd like to turn it over to Janet to take you through our results in more detail and then we'll be happy to take your questions.

Janet Haugen

Thanks, Ed and hello, everyone. Our first quarter performance reflected the challenges we faced in our U.S. Federal Government business, as Ed discussed. We were encouraged by the continued improvements in ITO revenue outside of our U.S. federal business, which grew by about 9% compared to the first quarter of 2010. And while our technology revenue was down for the quarter, our ClearPath revenue grew 7% year over year. We continued to exercise discipline in our control of operating expenses and optimizing cash across the company. And we continued our efforts to strengthen our balance sheet and capital structure through the issuance of mandatory convertible preferred stock, the related $211 million debt reduction in March and the additional April reduction of $179 million through the tender offer. Together, these transactions significantly reduced our debt and our interest expense, increased our equity and are accretive to our earnings per share after the impact of the charges associated with the debt reduction. The $31.8 million charge in the first quarter related to the March debt reduction, together with our operational challenges in the U.S. Federal business and the $17 million year over year increase in tax expense, resulted in a net loss for the quarter.

I would now like to provide some more details on our first quarter results. To start, please turn to Slide 5 for an overview of order trends in the quarter. We ended the first quarter with $5.8 billion in services backlog, which was slightly up sequentially from December 31, 2010, but down about a point on constant currency basis. Year over year, services backlog was up 2% versus March 31, 2010, but down 4% at constant currency rates. Geographically, North America services backlog outside of the U.S. federal marketplace grew sequentially and year over year. We also saw services backlog growth in U.K. and Continental Europe. And services backlog fell slightly in our Latin America and Asia Pacific regions.

First quarter services orders declined by double digits versus the first quarter of 2010. This decline was primarily attributable to lower year over year orders in outsourcing, infrastructure services and core maintenance, much of which was attributable to lower orders in our U.S. Federal business. These declines more than offset the orders growth in systems integration. The orders growth in systems integration resulted from a large public sector renewal, as well as a number of new business wins across a number of regions, particularly in the public sector. In the terms of geographic trends, we saw year over year services orders growth in North America outside of our U.S. Federal business. Orders in our U.S. Federal business were adversely impacted by the ongoing budget challenges and were down significantly. Orders in our other regions were also down versus the first quarter of 2010.

Slide 6 highlights our financial results in the first quarter. At the top line, we reported total revenue of $911 million in the quarter, which was down 7% year over year. Five percentage points of this decline was due to the $50 million decline in Federal Government revenue. Currency had a 2 percentage point favorable impact on our revenue in the quarter. Based on today's rates, we anticipate currency to have about a 4 to 5 percentage point positive impact on revenue in the second quarter of 2011.

We reported an operating profit of $41.9 million in the quarter, which was lower than the year-ago quarter's operating profit of $58.5 million. Declines in our gross profit margins more than offset continued reductions in operating expenses and resulted in an operating profit of 4.6%, down from 6% a year ago.

Other expense for the first quarter of 2011 was $23.8 million, which included a $31.8 million charge related to the March debt reduction. In the first quarter of 2010, other expense of $36.9 million included $35.4 million in foreign exchange losses, $20 million of which was related to the Venezuelan devaluation.

In the terms of U.S. GAAP pension expense, as we outlined on our last call, we expect approximately $33 million in pension expense in 2011 compared with pension income of about $3 million in 2010. For the first quarter of 2011, our pension expense increased $9 million versus the first quarter of 2010.

Beginning with first quarter 2011, we will show defined benefit pension income or expense in the corporate section in the segment reporting. We believe that it will make it easier to understand the operational performance of our segment and in the past, we've provided non GAAP information, which showed the segment performance without pension income or expense. Prior periods have been reclassified to be consistent with 2011.

Our pretax loss from continuing operations was $7.8 million compared to a loss of $4.9 million in the first quarter of 2010. At the tax line, we have a $28.2 million tax provision in the quarter compared with an $11.2 million tax provision in the year-ago quarter. As I have said previously, our tax provision continues to be highly variable from quarter to quarter depending upon the geographic distribution of our income.

We reported a net loss of $39.4 million in the quarter versus a net loss of $11.6 million in the year-ago quarter. Our diluted earnings per common share declined to a loss of $0.95 per share from a loss of $0.27 per share in the year-ago quarter.

Moving to our first quarter revenue and margins by portfolio, on Slide 7, you can see services revenue declined 6% year over year. Our U.S. Federal revenue decline drove nearly all of this decline. Currency had a 2 percentage point favorable impact on revenue in the quarter. Services gross profit margin as a percent of revenue decreased 40 basis points year over year to 18% from 18.4% in the first quarter of 2010. Declines in our U.S. Federal business gross margins more than offset improvements in the rest of the business. Our services operating margin declined 70 basis points year over year to 4% as declines in our U.S. Federal business gross margins more than offset improvements in the rest of the business. Systems integration and consulting revenue declined 3% year over year and while this rate of decline has slowed from prior periods, we still have more work to do to reach our goal of growing this business at market rates.

Within outsourcing, ITO revenue was down 5% versus the first quarter of 2010. ITO revenue from the U.S. Federal Government is down for the quarter due principally to the loss of revenue from the TSA contract, which ended in November 2010. We are pleased that outside of our U.S. Federal Government business, ITO revenue grew by 9% year over year.

Infrastructure services revenue declined 12% compared to the first quarter of 2011. Core maintenance declined 12% year over year and approximately half of that decline resulted from the sale of our Check Reader and Sorter business in the first quarter of 2010. Business Process Outsourcing revenue declined 2% versus the first quarter of 2010, principally reflecting continued declines in check processing volumes in our U.K. joint venture.

Approximately $750 million of the March 31, 2011, services backlog is anticipated to convert into second quarter 2011 services revenue. Over the past nine quarters, we typically have between 87% to 93% of our quarterly services revenue in our opening backlog. The balance of our service revenue comes from Sell and Bill business during the quarter.

Moving onto Technology on Slide 8, Technology revenue decreased 13%. While ClearPath revenue grew 7% year over year, sales of our other servers and other technology, which includes third party equipment, were lower. We reported a Technology gross margin of 51.1%, down slightly from the prior year. Our Technology operating margin declined 240 basis points to 10.9% compared with 13.3% in the first quarter of 2010.

Slide 9 provides more detail on the performance of our Federal Government business over the past five quarters. Our Federal Systems business serves three primary sectors of the U.S. Federal Government: Civilian, Homeland Security and Department of Defense. Civilian agencies represent our single largest revenue base within the U.S. Federal Government, accounting for about 49% of our overall U.S. Federal Government revenue. Revenue from agencies within the Department of Defense and various intelligence agencies represented about 29% of our overall Federal Government revenue. And with the end of the TSA contract effective November 30, 2010, revenue from Homeland Security agencies has declined significantly as a percentage of our total federal revenue and in the first quarter of 2011, represented about 22% of our overall U.S. Federal Government revenue from Homeland Security agencies.

As you can see in the slide, our overall U.S. Federal revenue declined $50 million or approximately 24% in the first quarter of 2011 and $57 million, with a little bit more than half of that decline due to the end of the TSA contract. We were also impacted by the U.S. Federal Government budgetary situation. We ended the first quarter of 2011 with about $332 million of U.S. Federal services backlog, which was down 22% compared to the first quarter of 2010.

Slide 10 shows our first quarter revenue by geography and industry. Our North America revenue represented 41% of our revenue in the quarter and declined 16% in the quarter. Within North America, our revenue from the U.S. Federal Government represented 17% of our total Unisys revenue in the first quarter, and as we noted earlier, declined 24% year over year due to the absence of our TSA contract revenues, as well as the impact of the U.S. Federal budget challenges. Excluding the U.S. Federal Government business, our North America revenue declined by 9%. International revenue rose 1% in the quarter due to higher revenue in our Asia Pacific and Latin America regions. On a constant currency basis, international revenue was down 3%.

From an industry perspective, public sector remained our largest single industry revenue source. The 11% decline in public sector revenue year over year was driven primarily by the decline in our U.S. Federal Government revenue. All other public sector business was essentially flat compared to the first quarter of 2010. Revenue from commercial industry customers represented 33% of our first quarter revenue, while the financial sector was 23%.

Turning to Slide 11, you can see our revenue mix as we reshape our business. As we leverage our capabilities in systems integration, IT Outsourcing and Technology and continue to invest in those areas, our goal is to drive revenue growth at market rates in our systems integration and ITO business, ITO adjusted for the ending of the TSA contract, while holding Technology revenue stable.

Please turn to Slide 12 for an overview of our cash flow performance in the quarter. We generated $28 million of cash from operations in the first quarter of 2011 compared to a cash usage of $28 million in the year-ago quarter. As we've mentioned before, the first quarter of 2010 included the impact of $100 million reduction in receivables sold through the company's U.S. accounts receivable securitization facility. As part of our ongoing focus to reduce the cash requirements of our business model, capital expenditures were $43 million in the first quarter of 2011, down $26 million from $69 million in the first quarter of 2010. Our free cash flow usage was $15 million in the first quarter of 2011 versus usage of $97 million for the same period last year, which included the impact of the $100 million reductions in receivables sold through our securitization facility.

Depreciation and amortization was $53 million in the quarter, down from $67 million in the first quarter of 2010. We contributed $22 million in cash to our international pension plans in the first quarter of 2011 and for the full year, we continue to anticipate contributing approximately $115 million of cash to these pension plans. Our cash balance of $833 million at March 31, 2011, was slightly above the $828 million level we reported at December 31, 2010, and was $365 million above the level reported at March 31, 2010.

Please turn to Slide 13 for an update on our balance sheet and capital structure. We remain very focused on our 3 year goal of reducing debt by 75% or approximately $625 million from the September 30, 2010 level. We are pleased with the completion of a significant step towards that goal with the $211 million reduction in our high coupon long term debt notes that paid 14 1/4% and 12 3/4% interest during the first quarter, and using the proceeds from the mandatory convertible preferred stock offering we completed in February. Following up on that transaction, we used $220 million of cash on hand earlier in April to tender for more of this high coupon debt. Together, these actions reduced debt by approximately $390 million and will lower interest expense by approximately $53 million annually. The initial benefit in lower interest will start to be evident in the second quarter. From a cash perspective, this benefit is partially offset by the payment of $16 million in dividends annually on the mandatory convertible preferred stock during the 3 years until it converts into common stock.

Slide 14 illustrates the improvements we have made over the past 10 quarters in reducing the company's leverage. We ended the first quarter of 2011 with net cash of $214 million versus a net debt position of $379 million at the end of the same quarter last year. We have also provided the pro forma view of our debt and cash positions reflecting the impact of our tender offer, which closed on April 11. The tender offer reduced debt by approximately $179 million, using $220 million in cash on hand. As a reminder, we will record a one time charge of approximately $46 million in the second quarter in other income and expense related to the premium and expenses paid in association with the tender.

In closing, this was a challenging quarter for Unisys, particularly in the U.S. Federal Government space. However, we continued progress during the quarter in driving growth in our non U.S. Federal ITO business, higher ClearPath revenue, reducing operating expenses and strengthening our balance sheet. As we move through 2011, we will remain focused on extending our successes and addressing our challenges as we continue to drive towards our long term financial goals. Thank you for your time and now, I'd like to turn the call back over to Ed.

J. Coleman

Thanks very much, Janet. Operator, if we can, we'd like to open the call up to questions at this time.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Joseph Vafi with Jefferies & Company.

Joseph Vafi - Jefferies & Company, Inc.

I was wondering if we could just kind of talk about some of the subsegments of revenue to begin with, those areas in services and outsourcing that showed growth. Can you maybe give us a little more color on is that are there certain verticals or certain types of outsourcing where you're getting a little bit more traction in the marketplace, specific offerings, et cetera? And then on the ClearPath growth, was that a function at all of brand new business or was it mostly replacement cycle business?

J. Coleman

Thanks very much. On the services side, the strength again was primarily in end user outsourcing and it wasn't so much vertical plays there as strong horizontal performance, both in terms of account expansion as well as some new wins. The strength, I would characterize as being most evident in those situations where the client is looking to do both the remote services as well as the on site services in a combined and consistent way from one particular service provider. So that appears to be where it's playing the strongest. Our Converged Remote Infrastructure Management offering is gaining a lot of traction. So we're very pleased with the end user outsourcing performance. On the ClearPath side, I think once again, it's primarily a replacement and upgrade business more so than a new customer, new win business.

Joseph Vafi - Jefferies & Company, Inc.

Okay. So we should kind of expect some of the secular trends we've seen there to continue or maybe is the service offering in ClearPath just a little more compelling and driving, I guess, maybe a more aggressive replacement and upgrade cycle than maybe we saw a few quarters ago or something like that?

J. Coleman

I don't think it's necessarily more aggressive replacement and upgrade cycle. What we have been doing for several quarters now is continuing to enhance the platform to make it a more vibrant part of a modern infrastructure and developing a set of service offerings that help clients modernize the applications running on ClearPath in a way that they stay on ClearPath. So we continue to enhance the systems so that clients can now run Java applications on it or .net applications and it can fully participate in a solo [ph] environment. So what we believe we're doing is taking away any reason for why a client would want to move off of ClearPath, and in fact, we're giving them reasons to move workloads to it.

Joseph Vafi - Jefferies & Company, Inc.

Okay. Is there any potential margin left from TSA in this quarter, if maybe some of the personnel on that contract are being redeployed or there were some termination costs on that contract that maybe don't reoccur here as we look to Q2 numbers?

Janet Haugen

Joe, there is a little bit of that in the services operating margin in this quarter. For the TSA contract, which did end in November, a quarter of those employees we kept, a number transferred over to the new vendor. But we did terminate employees unfortunately this quarter and that did impact our operating profit.

Joseph Vafi - Jefferies & Company, Inc.

Okay. And then just on the other income line, Janet, I know we took the $32 million charge for the debt redemption. I guess net of that, excluding that charge, we would've had a nice amount of other income.

Janet Haugen

Right.

Joseph Vafi - Jefferies & Company, Inc.

What was going on with that other income outside of the debt redemption charge in the quarter?

Janet Haugen

The biggest item that's favorable going through there is the foreign exchange gains that we had in the quarter, of roughly about, a little bit under $8 million, $7.5 million worth of gains in the quarter, Joe.

Joseph Vafi - Jefferies & Company, Inc.

Okay, very good. And then just finally, relative to pension, I just missed that, where did the pension flow through on the P&L in the quarter?

Janet Haugen

The pension on the overall company results continues to flow through each of the different line items correlating to the Unisys workforce. When we've done this segment, we have services technology and then we have corporate and eliminations. In the segment results, we used to show those segment results with and without pensions using a non GAAP measure. What we've decided to do starting in January 1 of this year with the first quarter 2011 results is include all that defined benefit pension expense in the corporate and other in the eliminations column in the segments so that the segment reporting of services and technology does not include the defined benefit pension expense.

Joseph Vafi - Jefferies & Company, Inc.

Okay. Very good. Thanks very much, guys.

Janet Haugen

Thanks, Joe.

J. Coleman

Thank you.

Operator

[Operator Instructions] We'll go next to James Friedman with Susquehanna.

James Friedman - Susquehanna Financial Group, LLLP

Thank you for taking my questions. I wanted to ask about the government sector. Obviously, it's very challenging, not just for Unisys, but for all vendors. But in the instance that the public sector, as you call it the federal component, were not to recover, would that potentially put in jeopardy your 8% to 10% services operating margin targets?

Janet Haugen

We did have an impact on that in the first quarter, as we said in our comments. But if we do see a change in that environment, we will take the actions necessary to ensure that we get to the 8% to 10% services operating profit that are part of our 3 year goal. We remain committed to that and changes in the federal marketplace may make it a little bit more challenging to do, but we will drive to the goal that we've established.

James Friedman - Susquehanna Financial Group, LLLP

Okay. And then my follow up question was with regard to the technology division, Janet, is there so you had impressive secular, maybe cyclical, but arguably secular recovery and growth in ClearPath, but the gross margins actually declined. So is there is that because maybe you have new contracts in that division or is there utilization mix or maybe if you could elaborate as to why the top line is going one way but the margins, strangely this quarter didn't show that.

Janet Haugen

Sure. Okay. Within the Technology segment, we have three types of revenue. We have the ClearPath server family, which I already mentioned, did grow in the quarter. We have other servers, our ES server family line, which did not grow in the quarter and the combination of the ClearPath and the Enterprise Servers are what you see in our category that we refer to as Enterprise Servers. The third category in Technology is what we refer to as other technology. That's third party equipment that we are selling to our customers as the combinations where it's needed as part of our technology relationships. The overall technology revenue was down and that came in the areas, as I mentioned in my comments, lower revenue in our ES server family and in our third party product selling primarily. Both of those were not only down in revenue, but they were also down in margin and had, from an overall standpoint, suppressed the growth in revenue that we saw on ClearPath and suppressed the margins.

James Friedman - Susquehanna Financial Group, LLLP

Okay, so is that I know you don't guide that explicit, but is that something that we should contemplate as a trend in the model? Should we think about the technology gross margins declining or is that just a 1 quarter event?

Janet Haugen

I think when -- we look at the Technology business more on an annualized basis because there's a number of fixed costs in that business and the volume can really make a difference in how it's flowing through to the bottom line. So we'll continue to, like any technology company, see pressure in the margin just from a competitive standpoint. Our strategy of enhancing particularly in the ClearPath, the functionality and the features and we hope to offset some of that pricing pressure. And as we said on the prior calls, most of that ClearPath revenue is software related, not more hardware component to it, about 75% is software there. So we think those combinations when we're at an annual run rate, but the margins should hold kind of where we saw them in 2010. But perhaps be a little bit choppy as you go through the year depending upon the volume.

James Friedman - Susquehanna Financial Group, LLLP

Okay, that's really helpful. Thanks for the clarification.

Janet Haugen

Okay. Thanks, Jamie.

Operator

[Operator Instructions] And we'll take a follow up question from Joseph Vafi with Jefferies & Company.

Joseph Vafi - Jefferies & Company, Inc.

Janet, CapEx came down again. Is this -- if we kind of look back at the business over the last year or so, CapEx has been coming down. Are the new contracts that you're working on less CapEx intensive or are you getting more of out of your CapEx dollars these days? Is there any kind of changes to the model we should be aware of?

Janet Haugen

I think the trends you saw in the first quarter is consistent with the trend in CapEx in the second, third and fourth quarter of last year and part of our this is about 2 years now, we've been really focusing on trying to reduce the capital intensity of our business, predominantly in the IT Outsourcing area. So I think the first quarter is very much in line with what you saw from the CapEx expense in the second and the third and fourth quarter and what we would expect to see going forward.

Joseph Vafi - Jefferies & Company, Inc.

Okay. And then secondly, obviously the federal spaces is tightening up. Are there any maybe significant recompetes that you're focused on this year that maybe we should be aware of in that Federal business?

Janet Haugen

Joe, nothing that rises to the significance of the TSA recompete or TSA one we had in the prior year. We continue to work. And our biggest opportunities in our pipeline are more new business opportunities similar to the Google GSA type of opportunities that Ed mentioned. Some work we're doing with the U.S. Department of Agriculture. But more new opportunities and less pressure on recompete for this year than we saw in 2010, in the latter portion of 2009.

Joseph Vafi - Jefferies & Company, Inc.

Okay, great. And then just for modeling purposes, obviously there's the charge that's coming this quarter related to the tender and I think you've said that, that will be on a pretax basis. Do you have an idea of what the after tax effect of that's going to be?

Janet Haugen

The pre and the post-tax numbers are going to be the same because that is going to be incurred in the U.S. legal entity and given that we have full valuation reserves against the U.S. tax attributes, it drops down to a net income line pre and post at the same rate.

Joseph Vafi - Jefferies & Company, Inc.

Okay, great. Thanks very much.

Janet Haugen

Thanks, Joe.

Operator

And we'll go next to Chris McDonald with Kennedy Capital.

Chris McDonald - Kennedy Capital

Thanks for taking my question. I was wondering if you could maybe comment on how much of the softness in the Federal business you think was driven by the budget impasse and the continuing resolution dragging out versus just in general a more difficult environment that's sustaining?

J. Coleman

Well, of the $50 million decline that we saw year over year, about $30 million of that was tied to the TSA contract that went away at the end of 2010. The predominant portion of that remaining $20 million we view as being tied very closely to the budget issues, both in terms of ramping up new contract wins that we reported in Q4, as well as just getting the normal sell and bill around time and material work that we would normally see in a given quarter.

Chris McDonald - Kennedy Capital

Is that the kind of work that you could do any catch up on now that we've got a budget in place and contractors can go forward or is it generally hard to catch up, if you will?

J. Coleman

Honestly, I tend to look at time and material work as being kind of perishable. That when that period has gone by, you've missed that work and it'll get pushed out further and you'll do the work, but everything is going to get skewed one quarter and to the right. So I'm not sure there's a lot of catch up opportunity there on the shortfall in Q1. What we're working hard at is making sure that we begin to recover the volumes that we're looking for in Q2 and beyond.

Chris McDonald - Kennedy Capital

Okay, great. And then shifting gears to the Technology segment, it sounds like you kind of just experienced the normal lumpiness that you typically see in that segment there in Q1. I just want to make sure I understood your commentary right, Janet, that over the full year basis, you'd still expect a margin performance similar to what we saw in 2010, which implies some degree of significant improvement as we look at the last three quarters of the year on average. Is that fair?

Janet Haugen

Right. And as we've said a number of times, Chris, the Technology business, particularly the ClearPath business, is best measured on an annualized basis. So we're really happy that we got off to a strong start in the first quarter compared to the way we started the first quarter of last year. But that is not a business we are looking to get that flat to growing, not to have that continue growth quarter in quarter out because it's really going to be lumpy. And then because of that, the fixed costs in the business are there quarter in and quarter out and it can affect the margins based upon the volume we have in any given quarter. But looking at it on an annual basis, we think that we are doing the innovation work that we can to retain the clients and to hold the margins as close as we can to the 2010 levels.

Chris McDonald - Kennedy Capital

But it sounds like you're not backing off from that goal of having a flat Technology segment when you look at its performance over the next few years.

Janet Haugen

No.

J. Coleman

No.

Chris McDonald - Kennedy Capital

Okay, great. And then just one last minor item. As interest expense drops meaningfully now on a go forward basis, does that how much closer does that get the company to being able to capture some of the benefits from the favorable NOL position in the U.S.?

Janet Haugen

That will generate more income in the U.S. because the debt is in the U.S. legal entities and as we generate -- as we move to generating income into the U.S., that will be we will have available to us NOLs to offset any taxable income, at least in the near term based upon the NOLs we have available to us now.

Chris McDonald - Kennedy Capital

Do you think that's something that could happen as early as 1 quarter in 2011?

Janet Haugen

I don't want to comment on the geographic distribution of our income. I will say that by reducing the cost base in the U.S. that moves us closer to the point where we would have the ability to have U.S. taxable income that would be sheltered by the or be offset by the net operating loss and other tax credit carryforwards we have available to us.

Chris McDonald - Kennedy Capital

Okay. Thank you.

Janet Haugen

Thanks, Chris.

Operator

And we'll take our next question from Bill Smith with William Smith & Co.

Bill Smith - Lowering, Smith and Company

Ed, on your target to reduce debt by the end of 2013, you've made a lot of progress here this quarter and early April with a $390 million reduction, which I think that target is somewhere around $600 million or $625 million on the balance. Would you expect that to be paid down from cash flow from operations or would you expect that there might be another capital markets event to pay the balance down?

Janet Haugen

Bill, it's Janet. If I could just comment on that, we did make a significant step forward against the $625 million debt reduction goal with the activities in the first quarter. That goal to get the remainder of the way there is through the end of 2013. And when we look at what can be generated from operations, free cash flow from the business, we think that's going to be the primary place we look for, for the debt reductions, knowing you never say that you'll rule out any alternatives. But right now, from what we see, our primary source to pay down the remaining amount of our debt reduction target is through cash generated from the business.

Bill Smith - Lowering, Smith and Company

Very good. Thank you.

Janet Haugen

Thanks, Bill.

J. Coleman

Thanks, Bill.

Operator

And at this time, that does conclude our question and answer session. I'd like to turn the call back to you, Mr. Coleman, for any additional or closing remarks.

J. Coleman

Great. Well, thank you all for attending today's call. Thank you very much for your questions and we look forward to our next call following the second quarter results. Thanks very much.

Operator

That does conclude today's conference. Thank you for your participation.

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