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Unisys (NYSE:UIS)

Q1 2012 Earnings Call

April 24, 2012 5:30 pm ET

Executives

Niels Christensen -

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

Janet Brutschea Haugen - Chief Financial Officer and Senior Vice President

Analysts

Geoffrey K. Dancey - Cutler Capital Management LLC

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

William S. Smith - Wm Smith Securities, Inc.

Chris McDonald - Kennedy Capital Management, Inc.

Vlad Shteynberg

Operator

Good day, and welcome to the Unisys First Quarter 2012 Results Conference Call. At this time, I would like to turn the conference over to Mr. Niels Christensen, Vice President of Investor Relations at Unisys Corporation. Go ahead, sir.

Niels Christensen

Thank you, operator. Good afternoon, everyone, and thank you for joining us.

Earlier today, Unisys released its first quarter 2012 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. 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 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've 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.

And now I'd like to turn the call over to Ed.

J. Edward Coleman

Thanks, Niels. Hello, everyone, and thank you for joining us today to discuss our first quarter 2012 financial results.

We reported increased profits on higher revenue for the first quarter, and Janet will go through the numbers in detail, but please see Page 4 of the presentation for highlights.

We reported diluted earnings per share of $0.30 compared to a diluted net loss of $0.95 in the first quarter of 2011. Excluding debt reduction charges and pension expense in both years, our non-GAAP earnings per share increased to $0.97 from a non-GAAP loss of $0.04 a year ago.

Revenue grew 2% year-over-year overall and 3% in our services business. This was the second quarter in the past 3 that we've grown our top line. We've done this despite continued weakness in our U.S. Federal business where conditions remained challenging. Margins improved in our services business, although we still have work to do to get to our goal of a consistent 8% to 10% operating profit margin.

Our technology business delivered strong margins in the quarter on 5% lower revenue as we benefited from a richer mix of enterprise software.

We also continued to make progress in reducing debt during the quarter, retiring an additional $66 million of high-coupon notes. Since September 2010, we've cut our outstanding debt by more than $540 million or nearly 2/3 and we are now 87% of the way toward our year-end 2013 debt reduction goal. These actions have reduced our annualized interest expense by $69 million.

Moving to Page 5. From a demand perspective, we're encouraged by the interest we saw from customers for our enhanced services and solutions portfolio. Services orders grew double digits for the second straight quarter, driven by major signings by both new and existing clients. We saw a particular order strength for our end-user and data center outsourcing solutions. To drive profitable growth, we continue to enhance our portfolio and delivery capabilities to help organizations address major disruptive trends occurring in the marketplace. These trends, such as mobility, cloud computing and social computing, are changing the way people work, play and go about their lives. These technologies have freed people from the constraints of time and geography and enabled them to access and share information in a "24/7, always on, connected" global economy.

For companies and government agencies, however, these trends create significant challenges, for example, how to support and manage mobile end users who are increasingly using their own devices in the workplace; how to secure critical data from sophisticated hackers and cyber thieves; how to manage, store and use all the information being created to better know and serve customers; and how to manage all these new demands and requirements while also reducing cost. All of these trends create growth opportunities that we believe Unisys, with our systems integration expertise, our security skills, our outsourcing capabilities, our mission-critical technology, is well positioned to capitalize on.

As we look to the market, we see an opportunity for Unisys to differentiate ourselves as the company that provides services and solutions to help organizations operate more safely and securely in an ever more connected world. We deliver these solutions through project-based systems integration engagements or through an outsourced managed services environment. We also provide the technologies that supports secure, mission-critical environments.

In the area of IT outsourcing, for example, during the first quarter we closed significant new business with the American Red Cross to provide end user and data center managed services to make sure their 20,000 workers are well supported and connected in order to achieve their critical mission.

In systems integration, during the quarter, Unisys was selected to lead a consortium to design and build a sophisticated end-to-end security environment for the new international ITER experimental fusion facility being constructed in France. Our solution will expand parameter and surveillance security, identity and access management and command-and-control systems.

In China, TravelSky, the leading provider of IT solutions to the country's air, travel and tourism industry, is using the Unisys Secure Private Cloud Solution to provide a secure connected environment to handle transaction loads driven by the country's growing aviation sector.

In India, we're proud that our client, the Delhi International Airport, was recently judged the world's most improved airport and the #1 airport in the country by the prestigious SKYTRAX World Airport Awards. The awards cited significantly enhanced passenger service since the opening of the airport's terminal 3 a couple of years ago. Unisys served as master systems integrator for that project, integrating systems from 12 different companies to create a secure connected experience for air travelers.

In the U.S. Federal government, we're helping agencies such as the General Services Administration, the Department of Energy, NOAA, the USDA and Customs and Border Protection use new tools such as the cloud and mobile technology to collaborate and deliver services securely and more efficiently.

We continue to enhance our portfolio with innovative new services and solutions that help our clients make use of these new technologies to grow, reduce cost and improve service for their customers and constituents. Please look for a number of new solutions coming from us in the second quarter and for the remainder of the year.

In our technology business, clients rely on our ClearPath family for its security, performance, scalability and reliability to learn some of the world's most demanding mission-critical environments. We're rolling out an exciting long-term vision for our ClearPath platform that builds on these strengths while opening up the family to new uses and markets.

To sell our enhanced portfolio to the market, we continue to refresh our sales team and increase our sales’ effectiveness. We are also exploring new sales channels to broaden the available market for our portfolio in services and solutions. As we enhance our portfolio in sales and delivery resources, we are focused on continuously improving client satisfaction and service delivery. As I've said in the past, I firmly believe that the only long-term differentiation in a services and solutions business is the quality of those services and solutions as perceived by the customer. We're committed to providing consistently high levels of service and client satisfaction, and there's no better reflection of success in this regard than getting new and repeat work from existing clients, such as we saw during the first quarter with major contract extensions and renewals with clients such as the Internal Revenue Service, the National statistics Office in the Philippines and Bancolombia in Latin America.

Before closing, let me comment briefly on the most challenging part of our business right now, which continues to be our U.S. Federal government business. Our U.S. Federal revenue declined 20% in the quarter. As I said in the past, we think this will continue to be a challenging business for us in 2012 as we adjust to structural changes occurring in the budget environment in Washington. However, we believe the work we're doing on our portfolio positions Unisys to capitalize on these changes over the long term by helping the agencies to innovate while reducing cost. We're confident that we're taking the right steps and are focused on improving results in this part of our business.

In summary, despite challenges in the federal business, this was an improved first quarter and a good start to the year for Unisys. While we have more work to do, I'm pleased with our results and the progress we're making towards our financial and strategic goals. We're focused on continuing this progress in the quarters ahead, so please stay tuned as we continue to strengthen the competitive and financial profile of Unisys.

Thanks again for joining us today. Now 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. Turn to Page 7 for highlights of our financial results in the first quarter.

At the top line, we reported total revenue of $928.4 million in the quarter, which was up 2% year-over-year. Currency had no appreciable impact on our revenue in the quarter. Based on today's rates, we anticipate currency to have about a 3- to 4-percentage-point negative impact on revenue comparisons in the second quarter of 2012.

We reported an operating profit of $64.4 million in the quarter, which was $22.5 million or 54% higher than the year ago's operating profit of $41.9 million. A year-over-year increase of 150 basis points in our gross margin and lower operating expenses resulted in an operating profit margin of 6.9%, up from 4.6% a year ago.

The significant debt reductions we made last year were evident in the $16.6 million decrease in interest expense. From $25.9 million in the first quarter of 2011 to $9.3 million in the first quarter of 2012. Other expense for the first quarter of 2012 were $13.2 million, which included a $7.2 million charge related to the March debt reduction and $7 million of negative foreign currency impact. In the first quarter of 2011, other expense was $23.8 million, which included a $31.8 million charge related to debt reduction and a $7.6 million favorable foreign currency impact.

For the first quarter of 2012, our U.S. GAAP pension expense increased $16.7 million to $25.7 million versus $9 million in the first quarter of 2011. Within the income statement, pension expense is allocated to the cost of revenue, SG&A and R&D on the same basis of the salaries of active employees. Pension expense is not included in the services or technology segment results. We expect approximately $103 million of pension expense in 2012 compared to a pension expense of about $34 million in 2011.

For the first quarter 2012, we had pretax income of $41.9 million compared to a loss of $7.8 million in the first quarter of 2011. Before pension expense and debt reduction charges, our pretax income more than doubled to $74.8 million versus $33 million of pretax income last year.

At the tax line, we had a $22 million tax provision in the quarter on $42 million in pretax income compared with the $28 million tax provision on a pretax loss of $8 million in the year-ago quarter. As I have said previously, our tax provision continues to be highly variable from quarter to quarter depending on the geographic distribution of our income.

We reported net income of $13.4 million in the quarter versus a net loss of $40.8 million in the year-ago quarter. Excluding the impact of debt reduction charges and pension expense, Unisys generated adjusted EBITDA of $123.4 million for the quarter versus $108.7 million in the first quarter of 2011.

Our diluted earnings per common share improved to $0.30 per share from a loss of $0.95 per share in the year-ago quarter. The diluted EPS calculation reflected an average share count of 44.1 million shares for the first quarter of 2012 and 42.8 million for the first quarter of 2011. Excluding the impact of the debt reduction charges and pension expense, our first quarter 2012 non-GAAP diluted EPS was $0.97 per share compared to a loss of $0.04 in the first quarter of 2011.

Moving to our first quarter revenue, please turn to Page 8. Services revenue, which represented 89% of our revenue in the first quarter of 2012, grew 3% year-over-year. Currency had a one-percentage-point negative impact on services revenue in the quarter, so growth was 4% on a constant currency basis. Excluding our U.S. Federal business, services revenue grew by 7%.

Technology, which accounted for 11% of our revenue, decreased 5% year-over-year.

On Page 9, you can see our services revenue and margins. Services gross profit margin increased 90 basis points year-over-year to 18.9% from 18% in the first quarter of 2011. This reflected improved gross profit margins in systems integration, ITO, BPO and infrastructure services. Our services operating margin rose by 100 basis points year-over-year to 5%. Business integration and consulting revenue rose 8% year-over-year driven by a public sector activity. While this represented year-over-year systems integration revenue growth in 2 of the last 3 quarters, we still have more work to do to reach our goal of consistently growing this business at market rate.

Within outsourcing, ITO revenue was flat versus the first quarter of 2011. We are encouraged by the strong ITO order growth we've seen in the last 2 quarters, and our goal remains to grow at market rate in this business.

Moving on to technology revenue and margins on Page 10. While ClearPath revenue declined year-over-year, we remain committed to our annual goal of maintaining stable ClearPath revenue. Sales of other technology, which includes third-party equipment, declined by $2 million or 14%. Due to our richer mix of enterprise software in the first quarter, we reported a technology gross margin of 62.2%, up approximately 11 percentage points from the prior year. Our technology operating margin improved by almost 15 percentage points to 25.6% compared with 10.9% in the first quarter of 2011.

Turning to Page 11, which provides more detail on our U.S. Federal government revenue over the past 5 quarters. Our Federal Systems business serves 3 primary sectors of the U.S. Federal government: civilian, Homeland Security and Department of Defense and intelligence.

In the first quarter of 2012, civilian agencies represented our single largest revenue base within the U.S. Federal government, accounting for about 49% of our overall U.S. Federal government revenue. For the first quarter of 2012, revenue from agencies was in the U.S. Department of Defense and various intelligence agencies, represented about 23% of our overall federal government revenue. And revenue from Homeland Security agencies represented about 28% of our overall U.S. Federal government revenue in the first quarter of 2012.

Compared to the year-ago quarter, our overall U.S. Federal revenue declined $32 million or approximately 20% to $125 million in the first quarter of 2012. This decline resulted from delayed technology transactions and lower funding on -- from services contracts as well as the loss of some services contracts. We ended the first quarter of 2012 with about $330 million of U.S. Federal services backlog, which was essentially flat with the first quarter of 2011.

Page 12 shows our first quarter revenue by geography and industry. Our North America revenue represented 42% of our revenue in the quarter and rose 5% in the quarter. Within North America, our revenue from the U.S. Federal government represented 13% of the total Unisys revenue in the quarter. Excluding the U.S. Federal government, our North America revenue rose by 23%.

International revenue declined 1 percentage -- 1% in the quarter. On a constant currency basis, international revenue was flat.

From an industry perspective, public sector remained our largest single industry revenue source. The 3% decline in public sector revenue year-over-year was driven solely by the decline in our U.S. Federal government revenue. All other public sector business was up 8% compared to the first quarter of 2011.

Revenues from commercial industry customers represented 36% of our first quarter revenue, while financial sector was 22%. Our commercial revenue grew by 10%, while revenue from our financial services customers was down slightly.

For some comments on the orders, please turn to Page 13. For the second consecutive quarter, we saw double-digit year-over-year orders growth in our services segment. IT outsourcing orders grew by double digits, but we also saw increases in infrastructure services, business process outsourcing and core maintenance.

From a geographic perspective, we saw year-over-year services order growth in our North American, Latin American and Asia Pacific regions during the first quarter. Orders in our European region declined in comparison to the first quarter of 2011.

We ended the first quarter with $5.4 billion in services backlog, which was down 1% sequentially from December 31, 2011. Year-over-year, services backlog was down 6% versus March 31, 2011. Currency had a 2-percentage-point negative impact on a year-over-year comparison.

Approximately $700 million of the March 31, 2012, services backlog is anticipated to convert into second quarter 2012 services revenue. Over the past 13 quarters, we typically have had between 86% to 96% (sic) [93%] of our quarterly services revenue in our opening backlog. The balance of our services revenue comes from sell-and-build business during the quarter.

Moving to cash, please turn to Page 14 for an overview of our cash flow performance in the quarter. We generated $33 million of cash from operations in the first quarter of 2012 compared to $28 million in the year-ago quarter. We contributed $68 million in cash to our defined benefit pension plans in the first quarter of 2012 versus $22 million in the first quarter of 2011. For the full year, we continue to anticipate contributing approximately $240 million of cash to these plans. The contributions are reflected in the cash flow from operations.

Capital expenditures were $30 million in the first quarter of 2012, down $13 million from the first quarter of 2011. We continue to expect full year capital expenditures in the range of $150 million to $200 million.

Our free cash flow was $3 million in the first quarter of 2012 versus a usage of $15 million for the same period last year. Our free cash flow before pension cash contributions was $71 million for the first quarter of 2012 versus $7 million in the first quarter of 2011.

Depreciation and amortization was $42 million in the quarter, down from $53 million in the first quarter of 2011.

Our cash balance was $655 million at March 31, 2012, compared to $715 million at December 31, 2011. The decline in cash was principally related to debt reductions.

We are pleased with the continued progress we have made towards our debt reduction goal, and in the quarter, we reduced our high-coupon long-term debt by $66 million. This will further reduce interest expense by approximately $9 million annually.

Page 15 illustrates the improvements we have made over the past 14 quarters in reducing the company's leverage. We ended the first quarter of 2012 with net cash of $359 million versus $214 million at the end of the same quarter last year. Our first quarter 2012 net cash position is slightly higher than where we ended 2011. As previously stated, our December 31, 2013, goal is to have reduced debt to approximately $210 million, and we have about $85 million to go.

As indicated previously, we have made some changes to our geographic presence as we've evaluated opportunities to rationalize our geographic footprint. On March 30, 2012, we completed the sale of our interest in our South African joint venture. Going forward, we will serve this market through a distributor. This sale resulted in a gain of $11.3 million, which is included as a reduction to our SG&A expenses.

In light of the significant increase in cash contributions related to our U.S. pension plans, I would like to provide an estimate of future funding requirements related to our worldwide defined benefit pension plans over the next few years based on the assumptions and market conditions at December 31, 2011.

Turning to Page 16. Based on these assumptions, the estimated worldwide contributions of $240 million for 2012 would increase in 2013 to approximately $270 million. Then, contributions would begin to decrease, declining to approximately $225 million in 2014, $190 million in 2015, $165 million in 2016 and $145 million in 2017. Clearly, the discount rates and asset returns will not remain constant at the December 31, 2011 level, so these are estimates and will likely change at the end of this year and future years.

We wanted to provide this view, although subject to many variables, as we felt the context might be useful as it relates to potential future defined benefit pension funding requirements. As a reminder, the vast majority of these cash contributions relate to plans that have been frozen and, as such, are not adding new beneficiaries or accruing additional benefit obligations. Based on the assumptions we mentioned earlier, as we make cash contributions over time, the pension deficit will decline.

As we move through 2012, we will remain focused on driving towards our longer-term financial goals. Thank you for your time, and now I'd like to turn the call back to Ed.

J. Edward Coleman

Okay, thanks, Janet, very much. Operator, we'd like to open the call for questions now.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Geoff Dancey with Cutler Capital Management.

Geoffrey K. Dancey - Cutler Capital Management LLC

First, I want to say thanks for putting the slide in with the defined benefit plan funding estimate. That's very helpful, and thank you. So I may have a better idea of what your cash needs are going to be, going forward. So I had a couple of questions for you just in terms of getting a better handle on what your growth rate could be. When you were record-setting the system integration and the ITO, you've said, and maybe you've said this before, that you expect those segments to grow at market growth rates. Is there any way you could give me a better idea of what that means?

J. Edward Coleman

Yes. The way we've been thinking about systems integration and ITO is industry growth rates in the mid-single digits.

Geoffrey K. Dancey - Cutler Capital Management LLC

Okay. Now I just -- I was looking at a couple of surveys recently of chief investment officer spending expectations, and some of those looks a little lower than what I had thought they may be, actually with decline in spending. Does that relate to this type of market growth expectation?

J. Edward Coleman

Yes, I'm not sure if you're speaking to a broader industry-wide IT industry growth rates across the board or whether that's specific to systems integration and IT outsourcing. As we put our plans and targets together, we've thought about SI -- Systems Integration, ITO objectives to grow that in mid-single digits while we keep our technology business flat and primarily as it relates to our ClearPath software and server business.

Geoffrey K. Dancey - Cutler Capital Management LLC

Okay. And any further color you can give me on the infrastructure services, the core maintenance and the BPO in terms of future expected growth ranges?

Janet Brutschea Haugen

All right. The infrastructure services, the BPO and the core maintenance, those are all businesses that we've said that are not -- they're important to our business but not areas where we are investing, nor do we expect to see growth in those businesses over time. Just as a reminder, the core maintenance component of that is the maintenance services that we provide on our own equipment and software, and that has been declining. And that is something that we would expect to see declines in that over time. The business process outsourcing, we have not been making new investments in that area. We have a core group of contracts that are performing that we'd expect to continue, but that's not an area where we're looking for growth. And infrastructure services is where we're providing warranty and other types of support for companies like Dell, EMC, Lenovo, et cetera. And that is an area where we are not investing for future growth. So they're a smaller portion of the overall business. We've segregated those out as areas that we are going to try to maintain as best as we can, but in some cases, like core maintenance, we know, will decline over time.

Operator

And our next question comes from James Friedman with SIG. [Operator Instructions]

[Technical Difficulty]

Janet Brutschea Haugen

While we're waiting for Jamie to come on the line, let me just make sure that -- I want to clarify comments that I made with regard to our services opening backlog: That has historically represented between 86% to 93% of our next quarter's revenue. Jamie is that you there?

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

Yes, I apologize. I have -- it's a long story. I have this problem with my mute button sticking. I wanted to get a perspective. First off, I respect that you don't give much guidance and you don't give a quarterly guidance, but we're all human, and I'm wondering, in terms of the patterns of demand that you would anticipate seasonally this year, what are your thoughts about the revenue build now that you're off to a good start across the remaining quarters of 2012?

J. Edward Coleman

I think, on the services side, again, we would rely on Janet's comments about the opening backlog at services and the percent of revenue in a given quarter that comes from that opening backlog. And then I think, on addition to that, you have the technology business, which as you know, it can be a difficult one to assess quarter by quarter. That's why we continue to say that, that business is best looked at on an annual basis. And we're pleased that our objective was to keep the ClearPath business flat, and we've kept it flat 2009, 2010. 2011, actually, just a little bit of growth, and that continues to be our objective for 2012.

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

I think, in a number of public forums, you had said -- now it sounds like, in addition to the backlog, you also monitor business activity, which can waterfall into backlog, which can waterfall into revenue. So what observations are you seeing on the business activity front? Is that accelerating or decelerating?

J. Edward Coleman

I think it still continues to be a difficult demand environment. It's not one where we're so big that we're really subject to and controlled by macroeconomic trends while they certainly have some impact on us. But I think we'll probably see the same thing that everyone else sees. We're -- it looks like economic activity is ramping up, and then it'll hit a speed bump and tends to slow back down again. But you can look at our business and our performance in Q1, in Europe is an example, or in the United States and North America, maybe doing a little bit better than people would have expected based on economic growth patterns, and perhaps worse in Asia Pacific and Latin America than people would have expected. So we're not necessarily controlled by those macro trends.

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

Can I ask you about a little bit about the linearity across quarter you just reported? Did you notice -- did March accelerate from January? Or if you had, had to have these results early in the quarter, would this pretty much what have been what you expected?

J. Edward Coleman

Yes, I think services, the services part of the business kind of chugged along throughout the quarter. And the technology part of the business, again, it really depended on when those transactions hit is really what drives whether that's a first, second or third month of the quarter kind of activity.

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

Yes, so that's what I'm asking. Did they hit in the first, second or third month of the quarter?

J. Edward Coleman

I don't think we'd go into the details of where specific transactions fall. I don't think there's any particularly unusual about the quarter from a linearity standpoint.

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

Okay. And then Janet, I -- so you had this South African disposition, just -- you exited up in South Africa. We used to see these more frequently with Unisys. Is there -- are there more facets that you're looking to exit? Or have you pretty much exhausted that part of the opportunity?

Janet Brutschea Haugen

Jamie, a couple of years ago, we said that we were going to look at the geographic footprint. And you're right, earlier you did see us make some -- a little bit more in numbers. This is the first one in a while. We'll look -- as I said in my comments, we've evaluated the opportunities to rationalize it. This is one that came to conclusion in this quarter, but it's not something that we're going to comment on in the future. But I think we're comfortable with the footprint that we have now, and we'll always look for ways to see if we can optimize it to make us more productive, hit our goal and reduce any cash flow drain there.

J. Edward Coleman

If I could just add to it. Again, I think it's worth noting that this is really a shift in business model, more so than exiting a marketplace. So what we're doing is just positioning ourselves now to access that market through a distributor, whereas before we did it directly for -- through the joint venture.

Operator

And our next question comes from Bill Smith with William Smith and Company Investment.

William S. Smith - Wm Smith Securities, Inc.

A couple of things. One, Janet, I know you've mentioned this in the past about the pension obligation for every 25 basis points. I think it's $127 million in reduction in the pension obligation. Is that still -- if I'm looking at your chart, do I -- is it still okay to think about it in that way as well if rates change by 25 basis points, to think about that obligation be reduced by that amount?

Janet Brutschea Haugen

Great. So Bill, the 25-basis-point change in the discount rate will change the U.S. obligation by $127 million. And then in the international plans, it would change it by another $95 million. So if you look at our global plan in its entirety, the 25-basis-point change in the discount rate will change it by $222 million. And just as from an overview perspective: At year end, that discount rate was 4.96 for the U.S. plans and 4.65 for the international plan.

William S. Smith - Wm Smith Securities, Inc.

So the 25 basis points, if we have that kind of movement between now and the end of the year, would almost fund the $240 million that you've outlined here for this year?

Janet Brutschea Haugen

It doesn't exactly correlate directly that quickly. The December 31, 2011, underfunding in the U.S. was $1.6 billion and about $400 million internationally, for $2 billion in total. And so if we have the change in discount rates, the 25 basis points change would change that number by $222 million. It would -- if we had a change in the discount rate, that absolutely would, and it was an increase in that rate, it would decrease the amount of pension expense -- pension cash funding into the U.S. plans, all the other assumptions being the same based upon the way the calculations work. But it doesn't translate that quickly, Bill, into a reduction in the pension funding. It's kind of smoothed out that over time.

William S. Smith - Wm Smith Securities, Inc.

Okay. And you made a sale recently to Google for some of your patents. Could you comment at all on that 36 patents? And any other comments you can make about that sale and including the amount that you received for that?

J. Edward Coleman

Yes, Bill, on occasion, we've sold a license, some of our intellectual property. And as you might imagine, these transactions typically are subject to strict confidentiality provisions. We don't comment on them unless we believe they're material.

William S. Smith - Wm Smith Securities, Inc.

Yes. And is this -- I mean, with your patent portfolio -- and we have no idea what that value might be, but could this be an indication that there may be more of these types of opportunities for you in the future?

J. Edward Coleman

Yes, Bill, that's not something that we'd comment on.

Operator

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

Chris McDonald - Kennedy Capital Management, Inc.

I have a couple of questions. One is -- the pension reform that's been discussed and proposed in the Senate, I don't know if you have a sense for what that or how that might impact the company's position both from an obligation perspective and from a cash funding perspective.

Janet Brutschea Haugen

The pension reform -- it sounds like you know there's 2 different versions of it, one in the House and one in the Senate. Clearly, any reform that goes in should have a positive impact in reducing the amount of funding we have, going forward. But I don't want to comment on that until we see what the actual legislation, from a committee standpoint, actually gets implemented, if it does, before the elections, Chris. But we are obviously carefully monitoring that situation.

Chris McDonald - Kennedy Capital Management, Inc.

Okay, yes, I understand. Second, relative to debt reduction. So the company will be in a position this fall to basically call all the debt, as I understand it. Can you talk about just the various options you have there? If balance sheet's in such great shape, I'm curious to know, just in general, how the company might approach dealing with taking out some of that higher-cost debt.

Janet Brutschea Haugen

Sure. We have 2 tranches of public debt left and we have our October 2014 maturities of approximately $186 million, the 12 3/4% senior secured debt, that is callable at 106.375 in October of this year. We also have the January 15, 2016, unsecured senior notes, about $111 million of that left at 12.5%, and that's currently callable at 106.25. In the first quarter, we took actions to take out the 2015's, which were senior secured debt, and we called about $40 million of the 2016 unsecured senior notes. As we go forward, we'll continue to make progress to reduce our debt and hit our year-end debt reduction goal. I don't want to comment on what our future actions would be, but as you mentioned, all of our remaining debt is callable and we'll continue to look at ways to reduce the debt, to hit our goal as well as reduce our interest expense on the remaining debt. So we do have a number of options available to us. We continue to look at the options and look at the market to both hit our goal and reduce the interest expense on any remaining debt.

Chris McDonald - Kennedy Capital Management, Inc.

And then my last question is related to ClearPath. And the company has done a very good job of stabilizing the revenue base there. I was hoping to get a little more insight into what you see as targeted growth opportunities around that part of the business and how you think about the company's position in that market over the long term.

J. Edward Coleman

I think we continue to -- to think of ClearPath today and into the future as being a mission-critical platform. But the roadmap that we envision calls for us to continue to make that platform more and more open to running what would be considered non-traditional ClearPath workloads in terms of other operating environments, be it a Windows environment, Linux environment, UNIX environment, so that you can bring the mission-critical attributes that ClearPath provides in its operating environment to those other systems. And we think, in doing that, we will be able to look for new opportunities to grow ClearPath in those environments that are running applications and graphs that are considered less mission-critical environments but require the reliability and security that the ClearPath system can provide. They'll bring additional workloads requiring those kind of attributes to ClearPath. We're excited about the opportunities that, that provides for us.

Chris McDonald - Kennedy Capital Management, Inc.

And is that something that would evolve in a more gradual manner? Or would there be capabilities that the company could add and expand upon that would have a quicker impact in maybe opening up what the addressable market might look like in a more concentrated period?

J. Edward Coleman

I think we're doing that today and we'll continue to do it and accelerate that in the future. But for instance, today you can run -- bring Java workloads into the ClearPath environment today and pick up some of those attributes that ClearPath provides. We want to create an environment where it picks up all of those ClearPath attributes in reliability and security. You can run a lot of application modernization projects and bring new application development technologies to applications running on ClearPath today. We just want to continue to accelerate that and bring it to a broader and broader side of the marketplace. But I don't think it's ever -- we don't envision ClearPath ever becoming "a general-purpose system for everybody." It's really going to be about those applications where the client demands the highest levels of security and reliability and runs those attributes of ClearPath provides for those particular applications regardless of what they're written in.

Operator

Our next question comes from Vlad Shteynberg with Realm Partners.

Vlad Shteynberg

I have a few questions. First of all, I just wanted to clarify. Last quarter, I believe, Janet, you said that $680 million would come from the backlog. And I -- if I put that in your ranges of 86% to 93% for Q1, I would get the services revenue range of $730 million to $791 million versus the actual of $823 million. And so the actual, the $680 million, represents only 83% of that -- of the total services revenue. And so there was some outperformance. However, I wanted to clarify where that came from and your color on that.

Janet Brutschea Haugen

Sure. You're right, then. In the first quarter of 2012, we started that quarter with opening backlog of $685 million, and that was 83% of our services revenue in the quarter. I did say in my comments that the range of 86% to 93% is still typical. We saw that additional revenue just come from some sell-and-bill opportunities across the business in the quarter.

Vlad Shteynberg

Okay. And the second question is just on revenue growth. Is that based on your kind of backlog and the order rates that you see? And do you think that's sustainable for the year or for the next few quarters? Oh and the related question: North America was very strong at 23% year-over-year growth on sales. So maybe some color there?

Janet Brutschea Haugen

Sure. While we do not comment on our revenue growth expectations for future quarters, we do provide an estimate of what the -- we do provide the opening backlog going into the next quarter for the services business. But at this time, we do not provide guidance for revenue growth. We have outlined what our goals are for the business, as Ed covered earlier on the call. In North America, as you mentioned, we were up 23% year-over-year. And we -- that revenue growth came from public sector and ITO contracts. And we're happy to see that because our North America business had struggled a bit, given the economic situation in prior years and prior quarters, so we're happy to see that 23% year-over-year improvement.

Vlad Shteynberg

And so that's just kind of the general environment that -- so there isn't any one-off contract that shifted into this quarter or that quarter?

Janet Brutschea Haugen

No.

Vlad Shteynberg

It's more of a -- the general environment improvement.

Janet Brutschea Haugen

That's correct.

Vlad Shteynberg

Okay, great. Can you talk about the path to the 8% services margins from here in terms of buckets? Where are the savings going to come from?

Janet Brutschea Haugen

Okay, so the steps to get to the 8% services operating profit come from a couple of areas. One is hitting the revenue growth rate that Ed mentioned that are our strategic goals for both the systems integration and the ITO business, and including in that is some stability and some improvement in our federal business. The second is in the area of our operating efficiency; the percentage of our workforce that we have offshore; continuing to improve our portfolio offering to make sure that they are competitive, that we increase the use of automation. The third is making sure that our operating cost expenses are appropriate against our services revenue volumes. And while we have made major shifts and major savings in those costs in the past, we always continue and will continue to look for areas to be more efficient and effective in the general administrative areas while allowing us some room to invest in solutions development, marketing and improving our sales activity. So really, 3 areas: revenue growth at those -- for the strategy portfolios and some improvement in Federal; second, continuing to make sure that the way we deliver our offerings are cost effective from both the use of automation as well as using offshore resources and then lastly, continuing to look at opportunities for us to improve our SG&A as a percent of revenue.

Vlad Shteynberg

Okay, great. On the technology margins, so, great margins with significantly lower sales levels. Are they sustainable at these sales levels of around $100 million?

Janet Brutschea Haugen

We are -- on the technology business, the margins can vary from quarter to quarter based upon the total technology revenue and the mix of deals within the quarter. We look for that business on an -- as an annual basis. It has a fair amount of fixed costs in that business that are spread across the quarter, and it is very hard to call what one quarter will look like versus another. And so I think it's best measured on an annualized basis.

Vlad Shteynberg

Right. But I noticed that the -- this quarter, I wasn't expecting great margins, which I commend you on, with sales of around $100 million, so I'm wondering if there's been any step change in the margins of [indiscernible].

Janet Brutschea Haugen

I wouldn't view it as a step change in the margin. I would view it more the mix of deals that were in the quarter.

Vlad Shteynberg

Okay. And last question before I get in the queue. So I have you making over $2 in free cash flows despite making $5.50 of pension contributions this year, so -- and your net cash position now, you will continue to reduce debt. But the next question, of course, is what's going to be the cash usage even starting later this year when you get into more cash-generative quarters from a working capital perspective?

Janet Brutschea Haugen

In the near term, our goal, or as what we've stated, that by the end of the yearend, 2013, we want to reduce our debt by 75% from the September 2010 levels. We still have $85 million more to go and that's the first priority with regard to the use of cash. I -- and we have pension contributions, as we've outlined in the materials, for the quarter. And beyond that, I think it's too early for us to comment on additional cash usages until we complete those goals.

Operator

And ladies and gentlemen, it appears that's all the time we do have for questions today. I'll turn the call back to Mr. Coleman for any additional or closing remarks.

J. Edward Coleman

Well, great. Thank you, operator, and thanks to all of you for participating in today's call. We certainly appreciate that, and we look forward to speaking with you again on our next earnings call. Thank you very much.

Operator

And ladies and gentlemen, that does conclude today's presentation. We thank you for your participation.

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