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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The company reported a first-quarter 2011 net loss of $39.4 million, or $.95 per diluted share. The company's results in the first quarter of 2011 were impacted by a debt-reduction charge of approximately $32 million, discussed below, as well as a $50 million, or 24%, decline in revenue in its U.S. Federal government business. This is the first quarter without the Transportation Security Administration (TSA) contract, which expired at the end of November 2010. This contract provided approximately $30 million of revenue in the first quarter of 2010. The U.S. Federal business was also impacted by the U.S. Government's budget uncertainty that resulted in delays in awards and funding. Also impacting the first quarter of 2011 was a $17 million increase in the company's provision for income taxes. In the first quarter of 2010, the company reported a net loss of $11.6 million, or $.27 per diluted share, which included approximately $35 million of foreign exchange losses, including $20 million relating to the January 2010 currency devaluation in Venezuela. As part of the company's ongoing efforts to enhance its balance sheet and capital structure, during the quarter the company took actions to significantly reduce its debt and interest expense. On February 28, 2011, the company sold approximately 2.6 million shares of 6.25% mandatory convertible preferred stock for net proceeds of approximately $250 million. On March 30, 2011, the company used the net proceeds from the sale of the mandatory convertible preferred stock to redeem an aggregate principal amount of $211.0 million of its senior secured notes due 2014 and 2015. On April 11, 2011, the company completed a cash tender offer and purchased an aggregate principal amount of $178.9 million of its senior secured notes due 2014 and 2015. As a result of the debt reductions, annual interest expense will decrease by approximately $53 million. The annualized dividend on the mandatory convertible preferred stock will be approximately $16.2 million until mandatory conversion in 2014. Results of operations Company results Revenue for the quarter ended March 31, 2011 was $911.2 million compared with $977.4 million for the first quarter of 2010, a decrease of 7% from the prior year, primarily reflecting a $49.6 million decline in the company's U.S. Federal business. Foreign currency fluctuations had a 2-percentage-point positive impact on revenue in the current period compared with the year-ago period. Services revenue declined 6% and Technology revenue decreased 13% in the current quarter compared with the year-ago period. U.S. revenue was down 16% in the first quarter compared with the year-ago period. Both the overall services revenue decline and the U.S. revenue decline were principally driven by the decrease in the U.S. Federal government business. International revenue increased 1% in the current quarter principally due to an increase in the Asia Pacific and Latin American regions. Foreign currency had a 4-percentage-point positive impact on international revenue in the three months ended March 31, 2011 compared with the three months ended March 31, 2010. Total gross profit margin was 22.8% in the three months ended March 31, 2011 compared with 24.1% in the three months ended March 31, 2010, driven by lower revenue and margin in the U.S. Federal business. Selling, general and administrative expense in the three months ended March 31, 2011 was $146.0 million (16.0% of revenue) compared with $155.9 million (16.0% of revenue) in the year-ago period. The decline of 6% reflects the company's continued focus on cost reduction. Research and development (R&D) expenses in the first quarter of 2011 were $20.3 million compared with $20.8 million in the first quarter of 2010. For the first quarter of 2011, the company reported an operating profit of $41.9 million compared with an operating profit of $58.5 million in the first quarter of 2010, reflecting the lower U.S. Federal business revenue and margin. 16 -------------------------------------------------------------------------------- For the three months ended March 31, 2011, pension expense was $9.0 million compared with pension income of $.3 million for the three months ended March 31, 2010. In 2011, the increase in pension expense was principally due to lower expected returns on plan assets and higher recognition of net actuarial losses in 2011 compared with 2010. The company records pension income or expense, as well as other employee-related costs such as payroll taxes and medical insurance costs, in operating income in the following income statement categories: cost of revenue; selling, general and administrative expenses; and research and development expenses. The amount allocated to each category is based on where the salaries of active employees are charged. Interest expense for the three months ended March 31, 2011 was $25.9 million compared with $26.5 million for the three months ended March 31, 2010. As a result of the debt reductions discussed below, annual interest expense will decrease by approximately $53 million. Other income (expense), net was an expense of $23.8 million in the first quarter of 2011, compared with expense of $36.9 million in 2010. Included in the first quarter of 2011 were a charge of $31.8 million related to the debt redemptions, discussed below, and foreign exchange gains of $7.6 million. Included in the first quarter of 2010 were foreign exchange losses of $35.4 million, which included $19.9 million related to the Venezuelan devaluation. The loss from continuing operations before income taxes for the three months ended March 31, 2011 was $7.8 million compared with a loss of $4.9 million in 2010. The provision for income taxes was $28.2 million in the current quarter compared with a provision of $11.2 million in the year-ago period. As discussed in note (m) of the Notes to Consolidated Financial Statements, the company evaluates quarterly the realizability of its deferred tax assets by assessing its valuation allowance and by adjusting the amount of such allowance, if necessary. The company will record a tax provision or benefit for those international subsidiaries that do not have a full valuation allowance against their net deferred tax assets. Any profit or loss recorded for the company's U.S. continuing operations will have no provision or benefit associated with it due to full valuation allowance, except with respect to benefits related to income from discontinued operations. As a result, the company's provision or benefit for taxes will vary significantly quarter to quarter depending on the geographic distribution of income. In March of 2011, the UK government announced its intention to reduce the UK corporate tax rate from 27% to 26% effective April 1, 2011. There will also be a reduction in the main corporate tax rate from 26% to 25% effective April 1, 2012. These changes, which will be legislated at the same time, will not be considered to be enacted for U.S. GAAP purposes until all legislative procedures are completed and the Finance Act of 2011 receives Royal Assent. This is expected to occur in late June or early July of 2011. When enacted it is expected that the rate change will increase the company's income tax provision by approximately $8 million due to the impact on the UK net deferred tax assets. Segment results The company has two business segments: Services and Technology. Revenue classifications by segment are as follows: Services - systems integration and consulting, outsourcing, infrastructure services and core maintenance; Technology - enterprise-class servers and other technology. The accounting policies of each business segment are the same as those followed by the company as a whole. Intersegment sales and transfers are priced as if the sales or transfers were to third parties. Accordingly, the Technology segment recognizes intersegment revenue and manufacturing profit on hardware and software shipments to customers under Services contracts. The Services segment, in turn, recognizes customer revenue and marketing profits on such shipments of company hardware and software to customers. The Services segment also includes the sale of hardware and software products sourced from third parties that are sold to customers through the company's Services channels. In the company's consolidated statements of income, the manufacturing costs of products sourced from the Technology segment and sold to Services customers are reported in cost of revenue for Services. Also included in the Technology segment's sales and operating profit are sales of hardware and software sold to the Services segment for internal use in Services engagements. The amount of such profit included in operating income of the Technology segment for the three months ended March 31, 2011 and 2010 was $.8 million and $.4 million, respectively. The profit on these transactions is eliminated in Corporate. 17 -------------------------------------------------------------------------------- The company evaluates business segment performance on operating income exclusive of restructuring charges and unusual and nonrecurring items, which are included in Corporate. Effective January 1, 2011, the company changed the measurement of segment performance that it evaluates to exclude pension income or expense. Prior periods have been reclassified to conform to the 2011 presentation. All other corporate and centrally incurred costs are allocated to the business segments based principally on revenue, employees, square footage or usage. Information by business segment is presented below (in millions of dollars): Total Eliminations Services Technology Three Months Ended March 31, 2011 Customer revenue $ 911.2 $ 800.3 $ 110.9 Intersegment $ (21.6 ) .9 20.7 Total revenue $ 911.2 $ (21.6 ) $ 801.2 $ 131.6 Gross profit percent 22.8 % 18.0 % 51.1 % Operating profit percent 4.6 % 4.0 % 10.9 % Three Months Ended March 31, 2010 Customer revenue $ 977.4 $ 850.5 $ 126.9 Intersegment $ (23.1 ) .9 22.2 Total revenue $ 977.4 $ (23.1 ) $ 851.4 $ 149.1 Gross profit percent 24.1 % 18.4 % 52.0 % Operating profit percent 6.0 % 4.7 % 13.3 % Gross profit percent and operating income percent are as a percent of total revenue. Customer revenue by classes of similar products or services, by segment, is presented below (in millions of dollars): Three Months Ended March 31 Percent 2011 2010 Change Services Systems integration and consulting $ 284.9 $ 295.2 (3.5 )% Outsourcing 351.9 368.8 (4.6 )% Infrastructure services 110.1 125.6 (12.3 )% Core maintenance 53.4 60.9 (12.3 )% 800.3 850.5 (5.9 )% Technology Enterprise-class servers 99.6 102.4 (2.7 )% Other technology 11.3 24.5 (53.9 )% 110.9 126.9 (12.6 )% Total $ 911.2 $ 977.4 (6.8 )% In the Services segment, customer revenue was $800.3 million for the three months ended March 31, 2011 down 5.9% from the three months ended March 31, 2010, principally due to the decline in the company's U.S. Federal business. Foreign currency translation had a 2-percentage-point positive impact on Services revenue in the current quarter compared with the year-ago period. Revenue from systems integration and consulting decreased 3.5% from $295.2 million in the March 2010 quarter to $284.9 million in the March 2011 quarter. 18 -------------------------------------------------------------------------------- Outsourcing revenue decreased 4.6% for the three months ended March 31, 2011 to $351.9 million compared with the three months ended March 31, 2010. Exclusive of the decline in the U.S. Federal business, outsourcing revenue increased. Infrastructure services revenue declined 12.3% for the three month period ended March 31, 2011 compared with the three month period ended March 31, 2010, reflecting the company's de-emphasis of lower-margin business, as well as the shift from project work to managed outsourcing contracts. Core maintenance revenue declined 12.3% in the current quarter compared with the prior-year quarter. Approximately one-half of the decline was due to the February 1, 2010 sale of the company's U.S. specialized technology check sorter equipment and related U.S. maintenance business. Services gross profit was 18.0% in the first quarter of 2011 compared with 18.4% in the year-ago period. Services operating income percent was 4.0% in the three months ended March 31, 2011 compared with 4.7% in the three months ended March 31, 2010. The decrease in Services gross profit and operating profit margins reflected the lower revenue in the U.S. Federal business. In the Technology segment, customer revenue was $110.9 million in the current quarter compared with $126.9 million in the year-ago period for a decrease of 12.6%, as growth in ClearPath revenue was more than offset by declines in other technology revenue. Foreign currency translation had a positive impact of approximately 1-percentage point on Technology revenue in the current period compared with the prior-year period. Revenue from the company's enterprise-class servers, which includes the company's ClearPath and ES7000 product families, decreased 2.7% for the three months ended March 31, 2011 compared with the three months ended March 31, 2010. The decrease was due to lower sales of other servers which more than offset higher sales of the company's ClearPath products. Revenue from other technology decreased 53.9% for the three months ended March 31, 2011 compared with the three months ended March 31, 2010, principally due to lower sales of third-party technology products. Technology gross profit was 51.1% in the current quarter compared with 52.0% in the year-ago quarter. Technology operating income percent was 10.9% in the three months ended March 31, 2011 compared with 13.3% in the three months ended March 31, 2010. New accounting pronouncements See note (j) of the Notes to Consolidated Financial Statements for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition. Financial condition The company's principal sources of liquidity are cash on hand, cash from operations and its U.S. trade accounts receivable facility, which is discussed below. The company believes that it will have adequate sources of liquidity to meet its expected near-term cash requirements. Cash and cash equivalents at March 31, 2011 were $833.1 million compared with $828.3 million at December 31, 2010. At March 31, 2010, December 31, 2010 and March 31, 2011, the company had sold no receivables under its U.S. trade accounts receivable facility, compared with $100 million as of December 31, 2009. During the three months ended March 31, 2011, cash provided by operations was $28.4 million compared with cash used of $28.4 million for the three months ended March 31, 2010. One of the principal reasons for the increase in cash flow from operations was the $100 million decrease in utilization of the U.S. trade accounts receivable facility during the first quarter of 2010. Cash used for investing activities for the three months ended March 31, 2011 was $47.1 million compared with cash usage of $64.2 million during the three months ended March 31, 2010. Items affecting cash used for investing activities were the following: Net proceeds of investments were $1.3 million for the three months ended March 31, 2011 compared with net purchases of $.5 million in the prior-year period. Proceeds from investments and purchases of investments represent derivative financial instruments used to reduce the company's currency exposure to market risks from changes in foreign currency exchange rates. In addition, in the current quarter, the investment in marketable software was $11.4 million compared with $14.8 million in the year-ago period, capital 19 -------------------------------------------------------------------------------- additions of properties were $15.0 million in 2011 compared with $14.8 million in 2010 and capital additions of outsourcing assets were $17.0 million in 2011 compared with $39.0 million in 2010. Cash provided by financing activities during the three months ended March 31, 2011 was $12.0 million compared with cash usage of $62.1 million during the three months ended March 31, 2010. The current quarter includes cash proceeds of $250.4 million related to the issuance of preferred stock, net of issuance costs, and cash payments for long-term debt of $239.3 million (see discussion below). The prior-year quarter includes $64.9 million used to pay at maturity the remainder of the company's 6 7/8% senior notes due March 2010. At March 31, 2011, total debt was $619.3 million, a decrease of $204.7 million from December 31, 2010. On February 28, 2011, the company sold 2,587,500 shares of 6.25% mandatory convertible preferred stock for net proceeds of $249.7 million. Each share of mandatory convertible preferred stock will automatically convert on March 1, 2014 into between 2.1899 and 2.6717 shares of the company's common stock, subject to adjustment, depending on the volume weighted average price per share of the company's common stock over the 20 consecutive trading days ending on the third trading day immediately preceding the mandatory conversion date. At any time prior to March 1, 2014, holders may elect to convert all or a portion of their shares of the mandatory convertible preferred stock at the minimum conversion rate of 2.1899 shares of the company's common stock, subject to adjustment. The company will pay dividends on each share of the mandatory convertible preferred stock on a cumulative basis at an annual rate of 6.25% on the initial liquidation preference of $100 per share (equivalent to $6.25 per year per share). Dividends will accrue and cumulate from the date of issuance and, to the extent the company has lawfully available funds to pay dividends and the company's Board of Directors or an authorized committee of the Board of Directors declares a dividend payable, the company will pay dividends on March 1, June 1, September 1 and December 1 of each year prior to March 1, 2014 in cash and on March 1, 2014 or any earlier conversion date in cash, shares of the company's common stock, or a combination thereof, at the company's election. The first dividend payment will be June 1, 2011. The annualized dividend on the mandatory convertible preferred stock will be approximately $16.2 million until conversion. On March 30, 2011, the net proceeds from the sale of the mandatory convertible preferred stock were used to redeem an aggregate principal amount of $124.7 million of the company's senior secured notes due 2014 and an aggregate principal amount of $86.3 million of the company's senior secured notes due 2015 under the provisions of the indentures relating to the notes that allow the company to redeem, at its option, up to 35% of the original principal amount of each series of notes from the net cash proceeds of one or more equity offerings. As a result of these redemptions, the company recognized a charge of $31.8 million in "Other income (expense), net" in the three months ended March 31, 2011, which was comprised of $28.2 million of premium paid and $3.6 million for the write off of unamortized discounts, issuance costs and gains related to the portion of the notes redeemed. On April 11, 2011, the company purchased $44.1 million of its senior secured notes due 2014 and $134.8 million of its senior secured notes due 2015 that had been tendered into a cash tender offer conducted by the company. As a result of this purchase of notes, the company will recognize a charge of approximately $45.6 million in "Other income (expense), net" in the three months ending June 30, 2011, which is comprised of $42.1 million of premium and expenses paid and $3.5 million for the write off of unamortized discounts, issuance costs and gains related to the portion of the notes purchased. As a result of the debt reductions discussed above, annual interest expense will decrease by approximately $53 million. The company and certain international subsidiaries have access to uncommitted lines of credit from various banks. On May 16, 2008, the company entered into a three-year, U.S. trade accounts receivable facility. Under this facility, the company has agreed to sell, on an ongoing basis, through Unisys Funding Corporation I, a wholly owned subsidiary, up to $150 million of interests in eligible U.S. trade accounts receivable. Under the facility, receivables are sold at a discount that reflects, among other things, a yield based on LIBOR subject to a minimum rate. The facility includes customary representations and warranties, including no material adverse change in the company's business, assets, liabilities, operations or financial condition. It also requires the company to maintain a minimum fixed charge 20 -------------------------------------------------------------------------------- coverage ratio and requires the maintenance of certain ratios related to the sold receivables. Termination events include failure to meet covenants, materially incorrect representations and warranties, change of control and default under debt aggregating at least $25 million. At March 31, 2011 and December 31, 2010, the company had sold no receivables under this facility. The company is currently evaluating alternatives for a new credit facility. At March 31, 2011, the company has met all covenants and conditions under its various lending and funding agreements. The company expects to continue to meet these covenants and conditions. In 2011, the company expects to make cash contributions of approximately $115 million to its worldwide, primarily non-U.S., defined benefit pension plans. In accordance with regulations governing contributions to U.S. defined benefit pension plans, the company is not required to fund its U.S. qualified defined benefit pension plan in 2011. Based on current legislation, recent interest rates and expected returns for 2011, the company currently expects that it will be required to make a contribution of approximately $100 million in 2012 to this plan. The company may, from time to time, redeem, tender for, or repurchase its securities in the open market or in privately negotiated transactions depending upon availability, market conditions and other factors. The company has on file with the Securities and Exchange Commission an effective registration statement, expiring in June of 2012, covering approximately $.8 billion of debt or equity securities, which enables the company to be prepared for future market opportunities. Factors that may affect future results From time to time, the company provides information containing "forward-looking" statements, as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations of future events and include any statement that does not directly relate to any historical or current fact. Words such as "anticipates," "believes," "expects," "intends," "plans," "projects" and similar expressions may identify such forward-looking statements. All forward-looking statements rely on assumptions and are subject to risks, uncertainties and other factors that could cause the company's actual results to differ materially from expectations. Factors that could affect future results include, but are not limited to, those discussed below. Any forward-looking statement speaks only as of the date on which that statement is made. The company assumes no obligation to update any forward-looking statement to reflect events or circumstances that occur after the date on which the statement is made. Factors that could affect future results include the following: Future results will depend in part on the company's ability to drive profitable growth in consulting and systems integration. The company's ability to grow profitably in this business will depend on the level of demand for systems integration projects and the portfolio of solutions the company offers for specific industries. It will also depend on an improvement in the utilization of services delivery personnel. In addition, profit margins in this business are largely a function of the rates the company is able to charge for services and the chargeability of its professionals. If the company is unable to attain sufficient rates and chargeability for its professionals, profit margins will suffer. The rates the company is able to charge for services are affected by a number of factors, including clients' perception of the company's ability to add value through its services; introduction of new services or products by the company or its competitors; pricing policies of competitors; and general economic conditions. Chargeability is also affected by a number of factors, including the company's ability to transition employees from completed projects to new engagements, and its ability to forecast demand for services and thereby maintain an appropriate headcount. The company's future results will depend in part on its ability to take on, successfully implement and grow outsourcing operations. The company's outsourcing contracts are multiyear engagements under which the company takes over management of a client's technology operations, business processes or networks. In a number of these arrangements, the company hires certain of its clients' employees and may become responsible for the related employee obligations, such as pension and severance commitments. In addition, system development activity on outsourcing contracts may require the company to make significant upfront investments. The company will need to have available 21-------------------------------------------------------------------------------- sufficient financial resources in order to take on these obligations and make these investments. Recoverability of outsourcing assets is dependent on various factors, including the timely completion and ultimate cost of the outsourcing solution, and realization of expected profitability of existing outsourcing contracts. These risks could result in an impairment of a portion of the associated assets, which are tested for recoverability quarterly. As long-term relationships, outsourcing contracts provide a base of recurring revenue. However, outsourcing contracts are highly complex and can involve the design, development, implementation and operation of new solutions and the transitioning of clients from their existing business processes to the new environment. In the early phases of these contracts, gross margins may be lower than in later years when an integrated solution has been implemented, the duplicate costs of transitioning from the old to the new system have been eliminated and the work force and facilities have been rationalized for efficient operations. Future results will depend on the company's ability to effectively and timely complete these implementations, transitions and rationalizations. Future results will also depend, in part, on market demand for the company's high-end enterprise servers and maintenance on these servers. The company continues to apply its resources to develop value-added software capabilities and optimized solutions for these server platforms which provide competitive differentiation. Future results will depend on the company's ability to maintain its installed base for ClearPath and to develop next-generation ClearPath products to expand the market. The company faces aggressive competition in the information services and technology marketplace, which could lead to reduced demand for the company's products and services and could have an adverse effect on the company's business. The information services and technology markets in which the company operates include a large number of companies vying for customers and market share both domestically and internationally. The company's competitors include consulting and other professional services firms, systems integrators, outsourcing providers, infrastructure services providers, computer hardware manufacturers and software providers. Some of the company's competitors may develop competing products and services that offer better price-performance or that reach the market in advance of the company's offerings. Some competitors also have or may develop greater financial and other resources than the company, with enhanced ability to compete for market share, in some instances through significant economic incentives to secure contracts. Some also may be better able to compete for skilled professionals. Any of these factors could lead to reduced demand for the company's products and services and could have an adverse effect on the company's business. Future results will depend on the company's ability to mitigate the effects of aggressive competition on revenues, pricing and margins and on the company's ability to attract and retain talented people. The company's future results will depend on its ability to retain significant clients. The company has a number of significant long-term contracts with clients, including governmental entities, and its future success will depend, in part, on retaining its relationships with these clients. The company could lose clients for such reasons as contract expiration, conversion to a competing service provider, disputes with clients or a decision to in-source services, including for contracts with governmental entities as part of the rebid process. The company could also lose clients as a result of their merger, acquisition or business failure. The company may not be able to replace the revenue and earnings from any such lost client. The company's future results will depend upon its ability to effectively anticipate and respond to volatility and rapid technological change in its industry. The company operates in a highly volatile industry characterized by rapid technological change, evolving technology standards, short product life cycles and continually changing customer demand patterns. Future success will depend in part on the company's ability to anticipate and respond to these market trends and to design, develop, introduce, deliver or obtain new and innovative products and services on a timely and cost-effective basis. The company may not be successful in anticipating or responding to changes in technology, industry standards or customer preferences, and the market may not demand or accept its services and product offerings. In addition, products and services developed by competitors may make the company's offerings less competitive. 22 -------------------------------------------------------------------------------- The company's business can be adversely affected by global economic conditions, acts of war, terrorism or natural disasters. The company's financial results have been impacted by the global economic slowdown in recent years. If economic conditions worsen, the company could see reductions in demand and increased pressure on revenue and profit margins. The company could also see a further consolidation of clients, which could also result in a decrease in demand. The company's business could also be affected by acts of war, terrorism or natural disasters. Current world tensions could escalate, and this could have unpredictable consequences on the world economy and on the company's business. The company has significant pension obligations and may be required to make significant cash contributions to its defined benefit pension plans. The company has unfunded obligations under its U.S. and non-U.S. defined benefit pension plans. In 2011, the company expects to make cash contributions of approximately $115 million to its worldwide, primarily non-U.S., defined benefit pension plans. In accordance with regulations governing contributions to U.S. defined benefit pension plans, the company is not required to fund its U.S. qualified defined benefit pension plan in 2011. Based on current legislation, recent interest rates and expected returns for 2011, the company currently expects that it will be required to make a contribution of approximately $100 million in 2012 to this plan. Deterioration in the value of the company's worldwide defined benefit pension plan assets could require the company to make larger cash contributions to its defined benefit pension plans in the future. In addition, the funding of plan deficits over a shorter period of time than currently anticipated could result in making cash contributions to these plans on a more accelerated basis. Either of these events would reduce the cash available for working capital and other corporate uses and may have an adverse impact on the company's operations, financial condition and liquidity. The company's future results will depend on the success of its program to reduce costs, focus its global resources and simplify its business structure. Over the past several years, the company has implemented significant cost-reduction measures and continues to focus on measures intended to further improve cost efficiency. In prior years, the company has incurred significant cost reduction charges in connection with these efforts. Future results will depend on the success of these efforts as well as on the success of the company's program to focus its global resources and simplify its business structure. This program is based on various assumptions, including assumptions regarding market segment growth, client demand, and the proper skill set of and training for sales and marketing management and personnel, all of which are subject to change. Furthermore, the company's institutional stockholders may attempt to influence these strategies. The company's contracts may not be as profitable as expected or provide the expected level of revenues. In a number of the company's long-term contracts for infrastructure services, outsourcing, help desk and similar services, the company's revenue is based on the volume of products and services provided. As a result, revenue levels anticipated at the contract's inception are not guaranteed. In addition, some of these contracts may permit termination at the customer's discretion before the end of the contract's term or may permit termination or impose other penalties if the company does not meet the performance levels specified in the contracts. The company's contracts with governmental entities are subject to the availability of appropriated funds. These contracts also contain provisions allowing the governmental entity to terminate the contract at the governmental entity's discretion before the end of the contract's term. In addition, if the company's performance is unacceptable to the customer under a government contract, the government retains the right to pursue remedies under the affected contract, which remedies could include termination. Certain of the company's outsourcing agreements require that the company's prices be benchmarked if the customer requests it and provide that those prices may be adjusted downward if the pricing for similar services in the market has changed. As a result, revenues anticipated at the beginning of the terms of these contracts may decline in the future. Some of the company's systems integration contracts are fixed-price contracts under which the company assumes the risk for delivery of the contracted services and products at an agreed-upon fixed price. At times the company has experienced problems in performing some of these fixed-price contracts on a profitable basis and has provided periodically for adjustments to the estimated cost to complete 23 -------------------------------------------------------------------------------- them. Future results will depend on the company's ability to perform these services contracts profitably. The company's contracts with U.S. governmental agencies may subject the company to audits, criminal penalties, sanctions and other expenses and fines. The company frequently enters into contracts with governmental entities. U.S. government agencies, including the Defense Contract Audit Agency and the Department of Labor, routinely audit government contractors. These agencies review a contractor's performance under its contracts, cost structure and compliance with applicable laws, regulations and standards. The U.S. government also may review the adequacy of, and a contractor's compliance with contract terms and conditions, its systems and policies, including the contractor's purchasing, property, estimating, billing, accounting, compensation and management information systems. Any costs found to be overcharged or improperly allocated to a specific contract or any amounts improperly billed or charged for products or services will be subject to reimbursement to the government. In addition, government contractors, such as the company, are required to disclose credible evidence of certain violations of law and contract overpayments to the federal government. If the company is found to have participated in improper or illegal activities, the company may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the U.S. government. Any negative publicity related to such contracts, regardless of the accuracy of such publicity, may adversely affect the company's business or reputation. The company may face damage to its reputation or legal liability if its clients are not satisfied with its services or products. The success of the company's business is dependent on strong, long-term client relationships and on its reputation for responsiveness and quality. As a result, if a client is not satisfied with the company's services or products, its reputation could be damaged and its business adversely affected. Allegations by private litigants or regulators of improper conduct, as well as negative publicity and press speculation about the company, whatever the outcome and whether or not valid, may harm its reputation. In addition to harm to reputation, if the company fails to meet its contractual obligations, it could be subject to legal liability, which could adversely affect its business, operating results and financial condition. Future results will depend in part on the performance and capabilities of third parties with whom the company has commercial relationships. The company has commercial relationships with suppliers, channel partners and other parties that have complementary products, services or skills. Future results will depend, in part, on the performance and capabilities of these third parties, on the ability of external suppliers to deliver components at reasonable prices and in a timely manner, and on the financial condition of, and the company's relationship with, distributors and other indirect channel partners. More than half of the company's revenue is derived from operations outside of the United States, and the company is subject to the risks of doing business internationally. More than half of the company's total revenue is derived from international operations. The risks of doing business internationally include foreign currency exchange rate fluctuations, currency restrictions and devaluations, changes in political or economic conditions, trade protection measures, import or export licensing requirements, multiple and possibly overlapping and conflicting tax laws, new tax legislation, weaker intellectual property protections in some jurisdictions and additional legal and regulatory compliance requirements applicable to businesses that operate internationally, including the Foreign Corrupt Practices Act and non-U.S. laws and regulations. Financial market conditions may inhibit the company's ability to access capital and credit markets to address its liquidity needs. The capital and credit markets have experienced volatility and disruption. Financial market conditions may impact the company's ability to borrow, to refinance its outstanding debt, or to utilize surety bonds, letters of credit, foreign exchange derivatives and other financial instruments the company uses to conduct its business. Although the company intends to use cash on hand to address its liquidity needs, its ability to do so assumes that its operations will continue to generate sufficient cash. The company's services or products may infringe upon the intellectual property rights of others. The company cannot be sure that its services and products do not infringe on the intellectual property rights of third parties, and it may have infringement claims asserted against it or against its clients. These 24-------------------------------------------------------------------------------- claims could cost the company money, prevent it from offering some services or products, or damage its reputation. Pending litigation could affect the company's results of operations or cash flow. There are various lawsuits, claims, investigations and proceedings that have been brought or asserted against the company, which arise in the ordinary course of business, including actions with respect to commercial and government contracts, labor and employment, employee benefits, environmental matters and intellectual property. See note (l) of the Notes to Consolidated Financial Statements for more information on litigation. The company believes that it has valid defenses with respect to legal matters pending against it. Litigation is inherently unpredictable, however, and it is possible that the company's results of operations or cash flow could be affected in any particular period by the resolution of one or more of the legal matters pending against it. The company could face business and financial risk in implementing future dispositions or acquisitions. As part of the company's business strategy, it may from time to time consider disposing of existing technologies, products and businesses that may no longer be in alignment with its strategic direction, including transactions of a material size, or acquiring complementary technologies, products and businesses. Potential risks with respect to dispositions include difficulty finding buyers or alternative exit strategies on acceptable terms in a timely manner; potential loss of employees; and dispositions at unfavorable prices or on unfavorable terms, including relating to retained liabilities. Any acquisitions may result in the incurrence of substantial additional indebtedness or contingent liabilities. Acquisitions could also result in potentially dilutive issuances of equity securities and an increase in amortization expenses related to intangible assets. Additional potential risks associated with acquisitions include integration difficulties; difficulties in maintaining or enhancing the profitability of any acquired business; risks of entering markets in which the company has no or limited prior experience; potential loss of employees or failure to maintain or renew any contracts of any acquired business; and expenses of any undiscovered or potential liabilities of the acquired product or business, including relating to employee benefits contribution obligations or environmental requirements. Further, with respect to both dispositions and acquisitions, management's attention could be diverted from other business concerns. Adverse credit conditions could also affect the company's ability to consummate dispositions or acquisitions. The risks associated with dispositions and acquisitions could have a material adverse effect upon the company's business, financial condition and results of operations. There can be no assurance that the company will be successful in consummating future dispositions or acquisitions on favorable terms or at all. The company believes that its ability to use its U.S. federal net operating loss carryforwards and other tax attributes is limited. Internal Revenue Code Sections 382 and 383 provide annual limitations with respect to the ability of a corporation to utilize its net operating loss (as well as certain built-in losses) and tax credit carryforwards, respectively (Tax Attributes), against future U.S. taxable income, if the corporation experiences an "ownership change." In general terms, an ownership change may result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50 percentage points over a three-year period. The company regularly monitors ownership changes (as calculated for purposes of Section 382). Based on currently available information, the company believes that an ownership change occurred as of January 2011 for purposes of the rules described above. Moreover, any future transaction or transactions and the timing of such transaction or transactions could trigger an additional ownership change under Section 382. As a result of the ownership change, utilization of the company's Tax Attributes will be subject to an estimated overall annual limitation determined in part by multiplying the total aggregate market value of the company's common stock immediately preceding the ownership change by the applicable long-term tax-exempt rate (which is 4.10% for January 2011), possibly subject to increase based on the built-in gain if any, in the company's assets at the time of the ownership change. Any unused annual limitation may be carried over to later years. Future U.S. taxable income may not be fully offset by existing Tax Attributes, if such income exceeds the company's annual limitation. However, based on presently available information and the existence of tax planning strategies, currently the company does not expect to incur a cash tax liability in the near term. The company maintains a full valuation allowance against the realization of all U.S. deferred tax assets as well as certain foreign deferred tax assets in excess of deferred tax liabilities. 25-------------------------------------------------------------------------------- |