Unisys Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Financial statements are unaudited; amounts are in millions of dollars except per-share data.
Business context and period
Unisys reports Services and Technology segments. Services includes cloud and infrastructure, application, and business process outsourcing (BPO) services; Technology includes software, hardware, and related products. The company adopted Topic 606 revenue recognition on January 1, 2018 using the modified retrospective method, so prior periods were not restated.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $688.3 | $666.3 | $2,064.1 | $1,997.0 |
| Operating income (loss) | $55.8 | $(2.9) | $211.6 | $15.4 |
| Income (loss) attributable to Unisys | $6.1 | $(41.1) | $50.5 | $(115.8) |
| Diluted EPS | $0.12 | $(0.81) | $0.89 | $(2.30) |
| Gross profit margin | 22.3% | 15.5% | 24.6% | 18.1% |
| Interest expense | $15.9 | $16.4 | $48.2 | $36.4 |
| Income tax provision | $15.2 | $12.5 | $50.4 | $21.6 |
- Q3 segment trends: Services revenue rose 5.2% to $605.6; Technology revenue fell 8.9% to $82.7. Services operating margin was 3.1% versus 3.2%; Technology operating margin improved to 39.7% from 31.1%.
- Balance sheet at September 30: Cash and equivalents were $516.1, total debt $650.0, current assets $1,207.2, and current liabilities $842.2. Total deficit was $1,203.8; long-term postretirement liabilities were $1,814.0.
- Cash flow, nine months: Operating cash use was $77.4, compared with $36.3 used in 2017; investing cash use was $125.9 versus $98.6; financing cash use was $4.4 versus $334.7 provided. Cash, cash equivalents, and restricted cash decreased $230.2 to $533.9. Management attributed the increased operating cash use principally to receivables on Technology contracts signed late in the quarter.
Material changes versus the prior comparable period
- Q3 revenue grew 3.3%; management reported a 3-percentage-point negative foreign-currency impact. International revenue increased while U.S. revenue was flat.
- Reported operating results improved substantially, principally reflecting the absence of 2017 cost-reduction charges and savings from earlier actions. The company recorded a $0.9 benefit in Q3 2018 for changes in estimates, versus $46.1 of cost-reduction and other costs in Q3 2017. Nine-month 2017 charges were $99.0; 2018 recorded a $3.1 benefit for estimate changes.
- For the first nine months, the $53.0 Topic 606 adjustment for software license extensions and renewals contracted in late 2017 materially affected Technology revenue and profit. Management said revenue was relatively flat excluding this adjustment and reported operating income would have been $158.6 without it. The accounting change also produced a $21.4 cumulative-effect increase in accumulated deficit at adoption.
- Q3 SG&A declined to $90.9 from $97.8; nine-month SG&A declined to $274.5 from $314.2. Nine-month R&D expense fell to $21.8 from $31.3, principally due to increased capitalization of marketable software. A $7.3 gain on a U.K. property sale also benefited 2018 results.
- Nine-month interest expense rose to $48.2 from $36.4, principally because of the 10.75% secured notes issued in 2017. Cash and equivalents fell from $733.9 at year-end 2017 to $516.1.
Outlook, risks, contingencies, and unusual items
- Management stated it expects adequate near-term liquidity and reported compliance with lending covenants. It gave no specific revenue or earnings guidance in the supplied filing text.
- Remaining performance obligations were approximately $1.4 billion at September 30, with approximately 45% expected to be recognized as revenue by the end of 2019.
- Expected 2018 cash contributions were approximately $130.3 to worldwide defined-benefit pension plans; $117.5 had been contributed through September. Management expected full-year 2018 postretirement expense of approximately $73.2, versus $98.1 in 2017.
- The $440.0 principal amount of 10.75% senior secured notes is due in 2022; $213.5 principal of 5.50% convertible senior notes is due in 2021. Noteholders became eligible to convert during the quarter ending December 31, 2018 after specified indenture conditions were met. The revolving facility had $103.4 available net of letters of credit at quarter-end; its stated maximum was $145.0 and it has springing-maturity provisions tied to the notes.
- Management concluded disclosure controls were not effective at September 30 because of a material weakness in controls over Technology revenue recognition, including multiple-element arrangements. Remediation steps were underway, but management said the weakness would not be considered remediated until controls were tested and found effective.
- Unreserved Brazilian tax-related matters, including interest, were estimated at up to approximately $98. The Belgian government seeks approximately €28 in damages, while Unisys Belgium has a counterclaim of approximately €18.5. Louisiana’s Medicaid reimbursement case was dismissed by the state appeals court, but the state sought further review in October 2018. The filing cautions that litigation outcomes are unpredictable and could materially affect results or cash flows.
- Other notable items include a $6.6 tax benefit from releasing a valuation allowance on certain foreign deferred tax assets and adoption of highly inflationary accounting for the Argentine subsidiary beginning July 1; the latter’s Q3 impact was immaterial. The company expects the new lease standard, to be adopted January 1, 2019, to materially affect its consolidated financial position, but not materially affect results of operations or cash flows.
Important facts for investors to verify
- Separate underlying performance from Topic 606 timing effects, especially the $53.0 software renewal adjustment and the resulting reported nine-month profit improvement.
- Track operating cash conversion and collection of receivables tied to late-quarter Technology contracts, alongside cash levels and pension funding needs.
- Assess the cost, maturity, covenants, and potential conversion or dilution effects of the 2021 convertible notes and 2022 secured notes.
- Monitor remediation and testing of the Technology revenue-recognition controls material weakness.
- Follow developments in Brazilian tax exposures and other litigation, as well as the timing and outcome of the Louisiana review.