UIS Unisys

Courtney Holben Vice President of Investor Relations
Peter Altabef Chairman and Chief Executive Officer
Mike Thomson Senior Vice President and Chief Financial Officer
Jonathan Tanwanteng CJS Securities
Joseph Vafi Canaccord Genuity
Matthew Galinko Sidoti
Rod Bourgeois DeepDive Equity Research
William Smith William Smith & Company
Call transcript

Good day, and welcome to the Unisys Corporation's Fourth Quarter and Full Year 2020 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Courtney Holben, Vice President, Investor Relations. Please go ahead.

Courtney Holben

Thank you, operator. Good morning, everyone. This is Courtney Holben, Vice President of Investor Relations. Thank you for joining us. Yesterday afternoon, Unisys released its fourth quarter and full year 2020 financial results. I'm joined this morning to discuss those results by Peter Altabef, our Chairman and CEO; and Mike Thompson, our CFO.

Before we begin, I'd like to cover a few 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 morning to guide our discussion as well as other information relating to our third quarter performance on our Investor website, which we encourage you to visit.

Third, today's presentation, which is complementary to the earnings press release, includes some non-GAAP financial measures. The non-GAAP measures have been reconciled to the related GAAP measures, and we've provided reconciliations within the presentation.

Although appropriate under generally accepting accounting principles, the company's results reflect charges that the company believes are not indicative of its ongoing operations and that can make its profitability and liquidity results difficult to compare to prior periods, anticipated future periods or to its competitors' results. These items consist of pension, debt exchange and debt extinguishment, cost reduction and other expense. Management believes each of these items can distort the visibility of trends associated with the company's ongoing performance. Management also believes that the evaluation of the company's financial performance can be enhanced by use of supplemental presentation of its results that exclude the impact of these items in order to enhance consistency and comparativeness with prior or future period results. The following measures are often provided and utilized by the company's management, analysts and investors to enhance comparability of year-over-year results as well as to compare results to other companies in our industry: non-GAAP operating profit, non-GAAP diluted earnings per share, free cash flow and adjusted free cash flow, EBITDA and adjusted EBITDA and constant currency.

In addition, this quarter, we will be continuing to report non-GAAP adjusted revenue and related measures as a result of certain revenue relating to reimbursements from the company's check processing JV partners for restructuring expenses included as part of the company's restructuring program.

For more information regarding these adjustments, please see our earnings release and our Form 10-Q. From time-to-time, Unisys may provide specific guidance or color regarding its expected future financial performance. Such information is effective only on the date given. Unisys generally will not update, reaffirm or otherwise comment on any such information, except as Unisys deems necessary and then only in a manner that complies with Regulation FD. And 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 the actual results to differ materially from our expectations. These factors are discussed more fully in the earnings release and in the company's SEC filings. Copies of those SEC reports are available from the SEC and along with other materials I mentioned earlier on the Unisys Investor website. And now I'd like to turn the call over to Peter.

Peter Altabef

Good morning everyone, and thank you for joining us to discuss our fourth quarter and full year 2020 results. We ended 2020 in a strong position with improvements to our capital structure and liquidity and 2020 revenue and non-GAAP operating profit margins that exceeded our expectations. It is an exciting time at Unisys as we have transitioned to our new business unit structure in 2021 with a sharpened focus on higher growth, higher margin markets and solutions. We believe the changes we are implementing will better position the company to drive revenue growth and margin expansions over the coming years.

During the fourth quarter we continued our progress when the earliest COVID impacted quarters of the year with sequential services revenue growth supported by sequential growth in all segments. With ongoing strength in public sector, our Cloud business and ClearPath Forward services.

We also had stronger technology revenue growth than expected based on higher volumes of ClearPath Forward renewals than anticipated.

As a result, we returned to year-over-year revenue growth in the fourth quarter and our full year 2020 revenue exceeded our previously stated expectations. Non-GAAP operating profit margins expanded year-over-year in the fourth quarter and full year 2020 non-GAAP operating profit margins also exceeded our expectations.

We continued improving our capital structure and liquidity during the fourth quarter, about which Mike will provide more detail.

As a result, our leadership team is now able to dedicate their full focus to optimizing the business. To this end, we undertook a number of initiatives during 2020 to better position the company, many of which began contributing to results in the fourth quarter. We refined and enhanced our strategy and we'll be reporting in three new segments effective as of the beginning of 2021; Digital Workplace Services or DWS, Cloud and Infrastructure or C&I, and ClearPath Forward or CPF.

Our business platforms and services revenue and profitability will be reported as other in our results, given the diversity of solutions included in that group.

We are targeting higher growth and higher margin markets and solutions, with a particular focus on areas where we are recognized as a leader and have a clear differentiation.

For instance, we are shifting our focus within DWS from end user services to the higher growth, higher-margin, end user experience or EUX market, which has a three-year expected industry CAGR of 7% to 10% versus a 0 to 1% expected CAGR for the rest of the DWS market. Within C&I, we are specifically targeting cloud, which typically comes with higher margins, and within cloud we are focused on public and other highly regulated sectors where we have a strong track record. The expected three-year industry CAGR for public, excluding federal within C&I is 15% to 18% versus 11% to 12% for the rest of the C&I market. Within CPF, as you would expect, we already have significant share in license, SaaS and warranty work, but we are focused on growing ClearPath Forward's services which are the highest margin services in the company. The three-year expected industry CAGR for ClearPath Forward services is 1% to 3%, based on a $1.2 billion market opportunity. But we only had 13% of that market as of yearend 2020 and we expect to grow that market share.

As I said, our financial reporting will track these segments starting in 2021 and our new structure is expected to drive increased internal accountability for delivering results.

In addition to business unit initiatives, we are also continuing to implement change across the entire company.

During 2020 we enhanced our go-to-market approach with a new digital sales platform, upgraded training, and a more proactive sales approach, and we are digitizing and industrializing our delivery and operations.

We have instituted new workforce management initiatives and are implementing a new ERP system.

We have provided more insight on all of this at our recent investor event, the slides and replays of which are available on our newly updated Investor Relations website which we encourage you to visit. The go-to-market improvements we instituted in 2020 are gaining traction, with TCV up 22% year-over-year in the fourth quarter and 8% for 2020 overall, and we believe the other operational changes I highlighted position us to drive revenue growth and margin expansion going forward. That said, although TCV improved in the fourth quarter, services backlog was down 10.5% year-over-year to $3.4 billion at year end 2020, given the COVID related disruptions to client purchasing decisions earlier in the year.

We are also still in the early stages of evolving our DWS offerings to focus more on EUX, which will be a key driver of growth in that segment.

As a result, we are guiding to 2021 revenue growth of 0 to 2% with acceleration in growth expected in 2022 and 2023, as we emerge from the COVID impacted period and grow our EUX offerings.

We expect Cloud and Infrastructure to be our fastest growing segment in 2021. DWS is anticipated to grow more modestly in 2021 with stronger growth in subsequent years as I just noted. The ClearPath Forward segment is expected to grow slightly year-over-year in 2021 Margin expansion is expected to be relatively consistent over the coming years with profitability improvements driven in part by operational efficiencies, some of which are already benefiting us as labor as a percent of revenue was down year-over-year again in the fourth quarter, and for 2020 overall. The transition to higher margin end user experience and cloud revenue is expected to further benefit profitability.

We are guiding to non-GAAP operating profit margin of 9% to 10% and adjusted EBITDA margin of 17.25% to 18.25%, both up approximately 200 basis points year-over-year at midpoint.

Our enhancements to our Digital Workplace Services platform continued during the fourth quarter with integration of new AI automation and analytics to provide more proactive detection and resolution of problems, aimed at improving end-user experience.

We are offering cloud-based virtual desktop as a service through our partnership with VMware to allow enterprises to provide upstreaming and virtual desktops to workers as their primary workspace. Through our partnership with [indiscernible] Group we are leveraging virtual work to provide advisory services, identifying infrastructure changes needed to allow clients and employees to work anywhere with the same security and effectiveness as when they are in the office.

Additionally, the profitability of a number of key DWS contracts improved over the course of 2020.

As an example of our work in DWS, during the fourth quarter we signed a contract with a global healthcare provider for Unisys InteliServe, artificial intelligence, robotic process automation, to improve the user experience to 39,000 employees globally. Also during the fourth quarter, Information Services Group or ISG recognized Unisys as a global leader in digital workplace services in their reports on the U.S., the UK and Brazil. ISG highlighted our InteliServe digital workplace automation platform as a strength for Unisys in addition to our industry focused consulting for the post-COVID world. These recognitions come after being named again to the Gartner managed workplace services Magic Quadrant in North America earlier in 2020. We completed a number of development initiatives in the fourth quarter within Cloud and Infrastructure to enhance our CloudForte Solutions platform, including a new release of AI Ops that helps optimize cloud infrastructure and improvements to our cloud management platform that accelerates deployments of cloud resources with appropriate security to reduce implementation efforts from several days to a few hours. The new and updated capabilities increase automation of existing and new features, leading to enhanced productivity and greater flexibility and agility for our clients. And we plan to continue evolving our cloud offerings over the course of the year.

As with DWS, we have also improved the profitability of a number of key C&I contracts over the course of 2020.

During the first quarter we expanded our work for U.S. State Government to support the state's workforce model that is quickly shifting to a remote first strategy.

We will provide CloudForte as the foundation for a virtual infrastructure, that will secure sensitive applications and regulated data by preventing users from printing, copying or downloading data into unsecured devices. In the fourth quarter, as with DWS, ISG also recognized us as a leader in public cloud solutions and services its quarterly reports on the US, UK and Brazil. They specifically highlighted CloudForte, noting that it provides a comprehensive delivery model leveraging automation, AI and best practices. We were also named a leader in the December NelsonHall Vendor Evaluation for cloud infrastructure brokerage, orchestration and management, and the overall market segment. We were placed in the leader quadrant in all three areas evaluated. Overall cloud services, cloud brokerage services, and cloud orchestration services.

Going forward, Stealth will be included as part of our Cloud and Infrastructure business unit.

During the fourth quarter, we announced the latest version of Stealth (identity), our biometric identity management software. The new version includes enhanced features such as a managed identity interface that cross-references biometric results against records from fingerprint readers, scanners and other recognition methods to robust positive authentication and a mobile and Web accessible software development kit that provides enhanced customization and an improved user experience. Stealth(core) 6.0, our micro-segmentation solution, serving the security foundation from the cloud solutions we are leveraging for travel and transportation and hospitality clients related to COVID testing. With respect to ClearPath Forward, the client demand for these solutions was highlighted again in the fourth quarter with higher than expected volumes on renewals and technology revenue as I mentioned.

As an example, TravelSky, the leading provider of information technology solutions for China's air travel and tourism industry, renewed its contract for ClearPath Forward to process business-critical transactions, including passenger reservations, cargo bookings and load calculations.

During the fourth quarter, we extended a contract with our largest ClearPath Forward managed services client, providing more end to end managed services as part of our growth strategy in 2021. Managing our client's full environment enables us to significantly increase the level of services penetration into an account. In closing, I would like to say that I truly appreciate all of the hard work from our associates under unprecedented conditions during 2020. We ended the year in a strong position, are implementing exciting change, and are poised to drive improved growth and profitability going forward. With that, I will turn it over to Mike to provide more insight into our fourth quarter and full-year financial results. Mike?

Mike Thomson

Thank you, Peter and good morning everyone. In my discussion today, I will refer to both GAAP and non-GAAP results.

As a reminder, reconciliations of these metrics are available in our earnings materials. Likewise, information related to discontinued operations is available on our website.

We are reporting this quarter based on our historic reporting segments of services and technology.

As Peter noted, based on the changes outlined in our recent investor event, our reporting structure will align to our new business units starting in the first quarter of 2021. Historical results will be reclassified to reflect our new segment reporting structure and be completed in the coming months. I'm proud of how the Unisys team came together during the last year to enable us to emerge from 2020 in such a strong position. We made significant enhancements to our capital structure and liquidity and ended the year with better financial results than we anticipated. We transitioned to our new business unit structure at the beginning of 2021 and are executing against our enhanced strategy. We're excited about the opportunities this creates for driving revenue growth, margin expansion and cash flow over the coming years. I'll touch on some of these opportunities today, but first let me provide more color on our fourth quarter and full-year financial results. Starting with revenue, we returned year-over-year growth in the fourth quarter with total company non-GAAP adjusted revenue up 5.9% which was also a 16.5% sequential improvement versus the third quarter. This resulted in year-over-year revenue and non-GAAP revenue declines of 8.8% and 8.2% respectively, which exceeded our previously stated expectations for a 10% year-over-year decline in revenue. Services non-GAAP adjusted revenue was down 2.6% year-over-year in the fourth quarter and 9.8% for the full year 2020, driven by COVID impacted businesses including field services, travel and transportation, and BPO, as well as the expected declines in our UK check processing joint-venture. The COVID impacted businesses continue to recover and stabilize in the fourth quarter and services non-GAAP adjusted revenue grew 4.5% sequentially. Technology revenue grew 50.1% year-over-year in the fourth quarter and was also up 90.6% sequentially driven by higher than expected volumes on ClearPath Forward renewals. This also drove full year 2020 technology revenue to exceed our expectations with year-over-year revenue growth of 1%.

Moving to profitability, non-GAAP operating profit margin was up 790 basis points year-over-year in the fourth quarter to 14%, driving full year 2020 non-GAAP operating profit margin to 7.5%, which was up 30 basis points year-over-year. These results were supported by year-over-year services non-GAAP adjusted gross and operating profit margin expansion, both in the fourth quarter and in the full year. Services non-GAAP adjusted gross margin was up 360 basis points year-over-year in the fourth quarter to 18.4% and 90 basis points for the full year to 16.4%. Services non-GAAP adjusted operating profit margin was up 310 basis points year-over-year in the fourth quarter to 1.6% and 50 basis points year-over-year for the full year to 70 basis points. Technology gross profit margin was up 130 basis points year-over-year in the fourth quarter to 73.2% and Technology operating profit margin was up 460 basis points year-over-year to 54.3%. These improvements were helped by the stronger Technology revenue in the quarter.

For the full year 2020 Technology gross profit margin decreased by 400 basis points to 65% and Technology operating profit margin decreased by 530 basis points to 40.8%. These declines were largely driven by higher amortization charges, and higher third party hardware sales, which come with lower overall margins. Adjusted EBITDA margin expanded 770 basis points year-over-year in the fourth quarter to 21.5% and 140 basis points in 2020 to 15.8%. These results let us not only to beat our previously stated expectations, but also to outperform FactSet consensus estimates for 2020 on all key metrics, with the exception of GAAP EPS, the estimates for which did not fully reflect the expected fourth quarter charges, that we highlighted in our last earnings call.

In addition to the revenue and profitability results I just mentioned, we also continued improving our capital structure and liquidity in the fourth quarter. Adjusted free cash flow was up 59.6% year-over-year for the full year 2020 to $42.6 million. This increase was supported by an 18.6% reduction in CapEx spent year-over-year in 2020 to $130 million. Operating cash flow and free cash flow comparisons were impacted by voluntary pension contributions that we made during the year. We ended 2020 with a cash balance of $898. 5 million versus $538.8 million at year-end 2019.

We also continued executing against our plans to reduce our pension obligations during the fourth quarter.

As we talked about on our last call, we raised $485 million of senior secured notes during the quarter, the proceeds of which were used to reduce the pension deficit and make additional voluntary cash contributions. Based on year-end 2020 calculations and pro forma for the additional $200 million of cash from the balance sheet that we expect to contribute in 2021, the global pension deficit would be approximately $840 million versus the $1.75 billion at year-end 2019 and we would have just $11 million of expected remaining contributions to U.S. qualified pension plans, versus $826 million as of year-end 2019.

For all other plans we have approximately $190 million of required contributions through 2025.

Our net leverage at the year-end 2020, inclusive of the $840 million deficit I just noted was 2.4 times.

As we've discussed in addition to reducing the deficit in pension contributions, we focused on reducing the gross pension liabilities themselves with a previously stated goal of a billion dollar reduction by the end of the first quarter of this year.

During the fourth quarter, we made progress on this front, by removing over $275 million in gross pension liabilities through a bulk lump sum offering. In January, we announced the removal of just under $280 million of additional liabilities by a transfer to Mass Mutual. We're also targeting the removal of approximately $550 million of liabilities associated with our Netherlands plan and approximately $100 million of liabilities associated with our Swiss plan.

As a result of all of this, we now expect to be able to remove approximately $1.2 billion of gross liabilities by the end of the first quarter, $200 million more than our original goal.

During the first quarter, we'll also be retiring our remaining $84 million of convertible notes that are outstanding.

We will net settle the notes, which will result in approximately $3.4 million net shares being issued factoring in the cat call [ph] and based on the closing stock price as of February 18. The final share count will be determined prior to settlement, the net settlement method results in significantly fewer shares being issued than the full potential dilution as the remaining principle will be paid in cash.

As we've mentioned, we have transitioned to our new business unit structure as of the start of 2021, and our financial reporting will reflect those segments starting in the first quarter. We believe that the new reporting structure will provide additional insight into the key drivers of the business going forward, and will likewise increase internal accountability for driving results.

Additionally, within the newly defined business units, we'll be shifting to higher growth in higher margin markets and solutions, which we expect to create significant opportunity for revenue growth and margin expansion over the coming years, which in turn should drive improved free cash flow. We laid out our detailed expectations for the next three years as part of our investor event, and we encourage you to visit our new investor relations website that was relaunched in January to review the slides and replays from this event.

Regarding near term expectations, we're providing 2021 guidance for revenue growth of between 0% and 2%, non-GAAP operating profit margin of between 9% and 10%, and adjusted EBITDA margin of between 17.25% and 18.25%.

As Peter noted, our revenue growth is expected to accelerate in the years following 2021, as we progress in our transition and enhance our service offerings. Margin expansion on the other hand is expected to be relatively consistent over the three-year period, which is reflected in the guidance ranges we're providing. In 2021, our ClearPath Forward segment will include both licenses and services revenue generated by this franchise.

We expect total ClearPath Forward license revenue to be roughly flat year-over-year and split roughly 55% and 45% between the first and second half of the year, respectively with the third quarter expected to be the lightest quarter of the year and the fourth quarter expected to be the strongest. ClearPath Forward license revenue is expected to make up roughly 45% of the total ClearPath Forward segment revenue in 2021, and overall ClearPath Forward segment revenue is expected to be up low single digits year-over-year Services backlog was $3.4 billion as of the end of 2020 up 3% sequentially versus the third quarter.

We expect $375 million of this to convert into revenue in the first quarter of 2021. Overall we expect first quarter 2021 revenue to be down slightly year-over-year as our DWS business is still returning to its pre-COVID levels.

Lastly, there are some sizable charges expected during 2021 associated with the pension liability work we're undertaking, as well as our initiatives to realign our segments and enhance our efficiencies.

As I noted during the investor event, we're targeting $130 million to $160 million of run rate saves exiting 2021 from our efficiency efforts. Of the $130 million to $160 million, we expect to recognize half of the savings during 2021 with restructuring costs to achieve the savings of approximately, $40 to $70 million. We took charges related to this of approximately $30 million in the fourth quarter of 2020 and expect $10 to $15 million of additional charges in the first quarter of 2021. With respect to the pension liability removal work, we expect approximately $375 million of onetime, non-cash settlement charges during the first quarter of 2021. This would complete Phase I of our pension liability removal program and remove approximately $1.2 billion of gross pension liability.

We will of course continue to look for opportunities to remove additional pension liabilities in the future. To wrap up, I would like to again thank our Unisys associates for all of their efforts throughout 2020.

Your dedication and support helped us end the year with a strong liquidity position, achieve better financial results than expected, and positioned us for enhanced growth and margin expansion going forward.

So thank you all, and now I'll turn the call back over to Peter.

Peter Altabef

Thanks Mike very much. And Alyssa, I think we're now ready for questions.


[Operator Instructions] The first question is from Jon Tanwanteng of CJS Securities. Please go ahead.

Jonathan Tanwanteng

Good morning guys. Thank you for taking my questions and really nice time to 2020, it was a rough year for everyone, so it was nice to see. I was wondering if you could talk about your ability to drive signings in the services businesses in the first quarter. I know COVID spiked in a bunch of places around the world there has been additional lockdowns, maybe first of all address that? And number two, when would you expect backlogs to start increasing in services again as we go through the year? And I've got kind of one more after that.

Peter Altabef

Yes, Jon thanks. Those are great questions. Obviously there's some uncertainty about the timing of signing. I would tell you that our pipeline is up, both the qualified pipeline and even the prospective pipeline. We do expect over the course of the year, on your second question, to have backlog higher by the end of the year that it was obviously by the end of 2020.

So we expect not only new signings but accretive new signings to backlog. Exactly how much of that comes in the first quarter is a bit unknown. We certainly in EMEA, and in the U.S. we still have some tough COVID opportunities in terms of travel, in terms of sales.

We have a new digital sales platform that started last year that is allowing us to remotely sell much better than we had before our TCV went up for the year, our ACV went up for the year. But I would say the first quarter is still going to be a little tricky in terms of the amount of sales done. Added to that, and I think this is an industry question overall, when we look at the pipeline for 2021, we see a pretty good amount of signings for the year. That's not only true for us, but it's true for the industry.

One of the questions that I think we're all dealing with is, is there going to be a race to the bottom for the profitability of that business, as people really look to rebound on revenue over the course of the year from the challenges of last year? I think you can see from our forecasts with a modest amount of revenue gain, but a much higher amount of margin improvement.

We are focusing on margin improvement for the year. We don't have a real desire to do a race to the bottom on selling business that's not going to be long term accretive. We've got very strong margin accretive goals for each of the next three years.

So that's going to require us to be pretty disciplined on signing work that is consistent with that margin focus. But I would say that our focus really is margin first, revenue growth second. Jon, I hope that helps.

Jonathan Tanwanteng

Hey that's nice.

Mike Thomson

May be I can just add one little comment to that as well. I mean, typically what we see from our clients are kind of the February, March timeframe is when their budgets kind of get locked down and they start really infusing that into the marketplace.

So, Q1 is probably a little early from a normalcy perspective as to when we see that, but Peter was spot on, that we're anticipating the backlog to grow year over year, and obviously have that happen throughout the year.

Jonathan Tanwanteng

Got it. Mike, any thoughts on the pension reform language in the current release bill and if it's meaningful to you at all if it passes the way it is now?

Mike Thomson

Yes, look Jon, we've been pretty consistent on this and the language that's currently in the bill that's passed, the House is consistent with what we've been talking about, essentially permanently pension relief. And ultimately what it means to us is, if it passes in the way it's currently constructed, the $200 million that we were anticipating putting in this year, we wouldn't have to put in, and we wouldn't have another pension contribution to make on the U.S. qualified plans until like 2027 or 2028.

So, you know, from our perspective it really just leaves a good amount of cash in the coffers to continue with our growth strategy. Outside of that, really not a big change, and as you know we're prepared regardless of what Congress does to move forward on taking care of the pension from our perspective.

Jonathan Tanwanteng

Got it.

Just one more if I could, it sounds like you pull in from Tech renewals from '21 into the fourth quarter. I'm just wondering how that impacts Q1 in terms you are packing [ph] already? You gave some color on the year so just if you could…? Thank you.

Mike Thomson

Yes, Jon thanks for that. It wasn't really a pull forward. It was actually just increased volumes on our renewals, so really no impact on Q1 from our normal tech renewal perspective.

So again, it was just two clients in particular had higher volumes in their renewals than we had anticipated.

Jonathan Tanwanteng

Got it, that's great to hear. Thank you, guys.

Peter Altabef

You bet, thanks Jon.

Mike Thomson

Thank you, Jon.


Your next question is from Joseph Vafi with Canaccord. Please go ahead.

Joseph Vafi

Hi guys. Good morning and congratulations on a great year, 2020. Great, great job.

You deserve a lot of credit for it.

So just a question, I know you've been doing pretty well, and in state and local governments recently and I think there was, another win this quarter there. But perhaps, how does that pipeline look in deals for 2021? And then a quick follow up after that.

Peter Altabef

Yes, Joe, thanks. Thank you for the thank you. And thank you for getting up so early this morning. I would greatly appreciate it. What I would say is that, we call that our public sector as, you know, which is U.S. state and local, and then governments around the world. What I would say is, we look at our public sector, not only in U.S., but around the world. It's our strongest sector.

So we feel very good about U.S. state and local signings. We feel very good about our ability to grow outside the U.S. as well. In the US, obviously you have budget constraints, given the COVID situation, but you also have the realization that they can do business the way they are, the single biggest growth area for our state and local business in the U.S. is cloud based.

So that fits very, very well with our business unit strategy and focusing on the cloud and focusing on public cloud.

So we're pretty bullish.

As you know, our value proposition to governments is particularly the state and local in the U.S. always includes cost reductions from their current run rate.

So we do expect to get them up and running in a more vibrant cloud environment than they have now and save money while they do it. And we think that's formula for success, so we're bullish on the state and local pipeline.

Joseph Vafi

Great, thanks, Peter. And then, I know Mike, you mentioned some additional costs initiatives in 2021.

Just wondering if you could perhaps, detail strategy of where a little bit more of where that cost takeouts coming from and redeploying it? I know, you talked about margin expansion, but what's the trade off and ROIs that you're seeing now in investing for growth versus, perhaps letting that flow to the bottom line or from a P&L perspective?

Mike Thomson

Yes, thanks. Thanks for that, Joe.

So it's really coming across the board.

I think one of the major changes that we implemented in 2020, and we'll see the full valuation come through in 2021 and beyond is our Workforce Management Program. The team has done a really good job of implementing some tools, having visibility to the workforce.

Our cost of labor or cost of cogs, is frankly, the lowest as a percentage of revenue since I've been with the company which is coming into my sixth year here.

So really, it's really across the board. Its efficiency play Joe, more than anything. Clearly, that's coupled with the IntelliServe platform, the CloudForte platform.

We continue to automate and enhance, so that allows for some more efficiency as well.

So I wouldn't say it's one particular item. In general, its labor based and it's real estate based. We talked about on our last couple calls that post pandemic and our review of the real estate portfolio around the world, we found that we could operate a lot more efficiency.

So we're giving back some space in certain areas or allowing leases to lapse and consolidating space in other areas.

So I think those two are the primary benefits for that. And you saw from us on the Investor Day that our expectation kind of exiting 2023 is about 600 basis points of margin improvement and we think that that's going to be pretty much straight line over the course of '21, '22 and '23 with roughly two points of margin improvement per year. A good chunk of that is coming from those improvements that we've talked about. I also would like to just illustrate, and you touched on it a bit in your question here, there is a reinvest component here. We're looking between 20% and 30% of that save to be reinvested as we continue to enhance our skill sets, enhance the training for folks, hire more people in strategic areas, and talk about other areas of improvement for all of the lines of business.

So, I think Joe it is more horizontal view. It's across the board, and pretty consistent in the magnitude that we expect per year.

Peter Altabef

Yes, and if I could just follow on Mike's comment, Joe, and just to make sure you've got the numbers. That reducing the cost of labor as a percentage of our revenue is the end product, it's not the beginning. Right? You don't start saying, oh, let's go reduce our cost of labor. It's all of the workforce management, all of the systems, all of the leverageable IP that we put into our solutions. But just to give you those numbers, cost of labor as a percent of revenue was about 58.3% in ‘19, it was 55.6% in ‘20 and by 2023 we expect it to be 51%.

So that's, a nice chunk of some of our margin increase over the course of that time. But again, it there's a lot that goes into taking those costs down as a percent of revenue and getting that margin increase.

Mike Thomson

Yes, and maybe if I could, to Joe, just, real specific on the numbers. I mentioned that we took a charge in the fourth quarter of $30 million, we're anticipating between $10 million and $15 million in Q1. And we said the overall program would cost between $40 million and $70 million.

So most of the charges, frankly have already been incurred and so really it's about how much we reinvest and where we need that reinvestment.

Joseph Vafi

That's great. Thanks, that's helpful, Mike. And then just, I know that you're not really providing it for 2021, but how should we think about cash flow? I'd like to capital efficiency, and CapEx was a little lower in Q4. Was that kind of timing or was that anything notable we should be thinking about there? Thanks a lot.

Mike Thomson

Sure, thanks again, Joe. Look, if it wasn't for the voluntary pension contributions that we intend to make, and we'll see how the legislative element breaks, we would be free cash flow positive in 2021 and non-adjusted free cash flow positive, free cash flow positive. The CapEx number that we closed the year at, at about 130 as you know is about $20 million better than we had anticipated. Throughout the year we took it down to about 140 at the end of the third quarter and came in lower than that.

I think that it is really more a byproduct of what you've seen from us over the course of the last three years or so. That CapEx number just in a comparative purpose three years ago was about 110 [ph].

So our capital light strategy continues to drive that number down. We had talked about on Investor Day that we're also moving to a cash or working capital neutrality view, so that's going to have some improvements in cash flow as well.

So I think it's just what you've seen from us Joe, over the last couple years is just continual improvement and continual focus on driving down the CapEx number and enhancing our working capital profile.

Joseph Vafi

Great, thanks very much, Mike. Thanks, Peter.

Peter Altabef

Thank you, Joe.

Mike Thomson

Thank you.


Your next question is from Matthew Galinko with Sidoti. Please go ahead.

Matthew Galinko

Hi, thanks for taking my question.

Just a couple from me, one being, you touched on higher third party hardware cells in the mix, pressuring technology mark is a little bit this year. Obviously, the reporting structure is going to be different going forward, but just curious functionally how that, is that sort of the normal look, going forward or does that continue to bounce around a little bit and create some volatility in that margin?

Mike Thomson

Yes, look, it's really fairly normal and thanks for the question, Matt. Typically our hardware or third party hardware is anywhere between 10% and 15% of technology revenue in any given year, it's actually more a byproduct of the renewal cycle, the refresh schedules on the hardware and what the contract stipulates, so I wouldn't say there's any true normalcy to it. But when you look at a year-over-year compare, again depending on a refresh schedule, you can have more in year A versus year B. But I think on average, you should see that somewhere in the range of between 10% to 15% of technology there.

Peter Altabef

Yes, Matt, this is Peter.

You were higher, you were towards the higher end of the range this year. But I think you have to put in context what was happening with technology and hardware sales globally.

You've had a lot of work from home folks establishing and not everybody was prepared to do all of that work from home.

So that caused, if you will, a bit of positive pressure on hardware sales for us as we helped our clients get established.

Matthew Galinko

Got it, that makes sense. And then just I guess one follow up from me. And I guess its follow up on the pension question. I guess hypothetically, if there really bill does pass as kind of discussed on this call earlier, you've talked about M&A opening up as an option for you.

So, I guess I'm just curious, does that $200 million start burning a hole in your pocket or as you think about your outlook for deploying that capital internally or inorganically, what -- how do you think about that decisioning over the course of 2021? Is it something you can, can you see moving on M&A relatively quickly or is that not necessarily part of your -- how you're deciding on that? Thanks.

Peter Altabef

Yes, Matt, this is Peter. I guess I'll take it to start and then have Mike follow up and elaborate. The quick answer is that it is not burning a hole in our pocket. It is not even in our pocket right now, because we have allocated that to the pension take down, unless we don't need it for that, because of the legislation. That said, as you look at our cash balance for the year, even without that $200 million, we're in a significantly better cash balance than we were before and that money is not burning a hole in our pocket. I know you are familiar Matt, as is most of the people on this call. This is a hot market right now for mergers and acquisitions. The price of acquisitions is high and you have to really, really believe in your acquisition models in order to justify some of the pricing. That said, we have an active M&A team. We - but the goal of the team is modest. We're not looking for scale acquisitions. We're looking for some very specific capability acquisitions in our GWS business unit and in our cloud business unit.

So we think we'll be able to do that. But we don't, as I said, we're not in any particular rush to, and the size of those acquisitions are expected to be modest.

So I think that we will be in good shape with or without the $200 million. Mike?

Mike Thomson

Yes, look, I think you said it perfectly Peter. I mean, we're in a market here looking to acquire and enhance capabilities and frankly, that's happening with or without legislative relief.

We have $900 million-ish on our balance sheet in cash, and we have capacity to borrow if we needed to, but the reality here is, what we're looking for is the right deal and there's plenty of them out there. And as Peter noted, the market is fairly hot, but that doesn't mean we won't be prudent and ensure that what we're getting, not only helps us prospectively, but from our look back perspective, being able to take those competencies and play them back into our base is something that is important to us.

So, I would say Matt, in general we're looking hard at a whole bunch of different things and we're going to do the right thing by the company.

Matthew Galinko

All right, thank you.

Peter Altabef

Thanks, Matt.


Your next question is from Rod Bourgeois of DeepDive Equity Research. Please go ahead.

Rod Bourgeois

Hey guys. Hey, thanks for the thorough and clear presentation on all of these trends, very helpful stuff. I have a question about digital workplace and then a follow up on ClearPath Forward. In digital workplace, can you just talk about the latest state of how COVID is impacting demand? I'm especially interested in an update on the status of the Field Services portion of the business. It does seem that your ability to accelerate growth from 2021 into the next year is meaningfully contingent on how that business plays out.

So it would be great to get an updated sort of view on that.

Peter Altabef

Yes, so Rod thanks very much for the question. What I would say on Field Services is, we had a marginal uptick in the fourth quarter in terms of demand.

We expect a slight uptick in 2021, in terms of Field Services. But, none of our numbers anticipate a significant uptake in Field Services. That's not to say, I think we're at full run rate, but I think we're not far from full run rate.

So we I would say, we're about 80% of our 2019 run rate on Field Services, we expect that to go up a little bit over the course of the year. But in general as we look to the future, our revenue increase is really going to come from a move to end user experience, and not from increasing the Field Services revenues significantly. It's really the added value and you hear us talk about our InteliServe platform, you hear us talk about outcomes, you hear us talking about, moving from SLAs to really very objective customer value driven means of compensation. And all of that is because of the confidence we have in our end user experience.

So I think that's going to be the biggest uptick for our TWS business, but I think we expect a marginal uptick in revenue from Field Services.

Rod Bourgeois

So, but I guess the follow up on that is, is Field Services proven to be stable from 2021 into 2022 or is there a possibility that with your plan to enhance margins, and to shift into end-user experience could Field Services actually erode some or intentionally shrink in some ways?

Peter Altabef

Well, it depends on whether you're talking absolute dollars or percentage of revenue.

In terms of absolute dollars, no we don't expect it to be declining in absolute dollars. In percentage of revenue terms, we do because we expect the growth coming from areas other than Field Services.

Rod Bourgeois

Got it, okay great. And then on ClearPath Forward, clearly cloud adoption is a mega trend and COVID is further adding to that trend.

So I want to ask in ClearPath Forward how cloud related trends are impacting ClearPath Forward technology demand, what are the puts and takes that are happening for ClearPath Forward technology demand in light of all the cloud adoption that's happening in the world?

Mike Thomson

Well, that's a great question. I would say, to be frank, it's not as hurried as I thought it would be.

So, we put ClearPath Forward on Azure actually, in August of this past year. That's a big effort.

While our MCP platform is already on Azure, by the end of this year we expect our OS22 platform or 2200 platform to be on Azure, which will really complete our ClearPath Forward on Azure process.

We have a number of clients that are either using the Azure platform now or are looking at using the Azure platform.

I think effectively what that has done, it has given them the comfort that they know they have a public cloud environment they can switch to if they wish to.

I think over time, more and more of them will. We think that instead of people thinking about a five-year journey, they're thinking about, maybe a one to two-year journey. But it doesn't mean that they're pulling the ripcord right now and saying the absolute has to be on the public cloud.

So I think we actually have been quite happy with that. We're happy that we have the answer for them. We're happy that it works. We happy that clients are moving to it, but if we're talking about a large government and large financial institution that does not want to move to the cloud right now, there's no reason for them to do so.

So we actually think we have the best of both worlds right now. And we're very happy with the progress about moving ClearPath Forward on Azure.


Your next question is from William Smith with William Smith & Company. Please go ahead.

William Smith

Hi, Peter. Congratulations on another good year and all the progress that you've made. My question relates to the SAIC sale about a year ago and could you comment at all about how that's going and is there, because I know there was an expectation that there would be a tail there on some of that business, could you comment on that and how that's developed?

Mike Thomson

Yes, Bill absolutely. This, first of all, I think that has developed well. After the sale, we really thought there would be two revenue streams. Well, three revenue streams to us from SAIC, first on service levels for the transition and that went according to plan.

Secondly, on ClearPath Forward renewals as you will recall, we retained all of the intellectual property related to ClearPath Forward.

And so, SAIC is acting, if you will, as a distributor to the Federal Government for us, that has gone exactly according to plan. And then the third element is with respect to Stealth. And I would say that SAIC is one of our more active channel partners for Stealth, so that too is going according to plan.

You know, I referenced in my response some of the progress we have made on Stealth. And we really have two versions of that. One is what we call Stealth (identity), which is the biometric capabilities and the other Stealth (core), which is the micro-segmentation capabilities. We're really using both in terms of our current client activities. And I would say that while the SAIC channel is important to us, a bigger channel right now is with respect to healthcare, to travel and transportation, all with respect to COVID and COVID testing.

So we announced a partnership with Inspire Health last year, and we're quite active, working with Inspire, as well as opportunities in both travel and transportation and healthcare within Stealth is a very vibrant solution for some of the testing opportunities that are upon us.

William Smith

Okay, great, thank you.

Mike Thomson

Thanks, Bill.


That concludes our question-and-answer session. I would like to turn the conference back over to Peter Altabef for any closing remarks.

Peter Altabef

Thanks very much Alyssa. I'd like to thank everyone for joining us. I’d like to thank Mike for both his presentation and commentary. One item that I referred to in my remarks, which I would recommend to you again, for those of you who were not able to join us on our Investor Day in January, we have a full set of the slides, as well as of the transcripts and the audio from that. I hope that you will find that useful. We didn't spend a lot of time today talking about the new business unit structure that we have put in place as of January with our business units. Obviously, we will start reporting on them as of the end of the first quarter. But we really laid out the strategy, the rationale, and the effect we think that business unit approach will have on the company in our Investor Day presentations, and we would recommend them to you. With that, I want to again thank you. Courtney Holben and our Investor Relations team, Mike and I and the rest of the leadership team stand ready to continue the dialogue with you whenever appropriate.

So thank you guys very much everyone.


The conference has now concluded. Thank you for attending today's presentation.

You may now disconnect.