Unisys Corporation (UIS) Earnings Call Transcript & Summary

Good day, and welcome to the Unisys Capital Structure and Pension Strategy Discussion Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Ms. Michaela Pewarski, Vice President of Investor Relations. Please go ahead, ma'am.

Thank you, operator. Good afternoon, everyone, and thank you for joining us. I'm joined this morning by Mike Thomson, our CEO and President; and Deb McCann, our Chief Financial Officer, both of whom will discuss our capital structure and pension strategy. Today's remarks and question-and-answer session will not include any information related to the company's second quarter results, which will be reported after market on July 30 and management's call to discuss the results will take place at 8 a.m. Eastern Time on July 31. As a reminder, certain statements on today's call contain estimates and other forward-looking statements within the meaning of the securities laws. We caution listeners that the current expectations, assumptions and beliefs forming the basis of our forward-looking statements include many factors that are beyond our ability to control or estimate precisely. This could cause results to differ materially from our expectations. Please refer to the forward-looking statements section of today's presentation furnished on Form 8-K and in our most recent Forms 10-K and 10-Q filed with the SEC. Today's presentation also includes forward-looking statements and projections relating to future deficit and contributions for our U.S. qualified defined benefit pension plans. These projections were prepared by the company's independent actuary, WTW and are based on certain estimates and actuarial assumptions that are subject to change. We do not, by including these statements assume any obligation to review or revise any particular forward-looking statements or projections relating to our pension plans referenced herein in light of future events. We will also be referring to certain non-GAAP financial measures such as net leverage or adjusted EBITDA that excludes certain items such as post retirement expense, cost reduction activities and other expenses, the company believes are not indicative of its ongoing operations as they may be unusual or nonrecurring. We believe these measures provide a more complete understanding of our financial performance. However, they are not intended to be a substitute for GAAP. The non-GAAP measures have been reconciled to the related GAAP measures, and we have provided reconciliations within the presentation. The slides accompanying today's call are available on our investor website and in the presentation furnished on Form 8-K that we filed this morning. With that, I'd like to turn the call over to Mike.

Thank you, Michaela. Good afternoon, everyone, and thank you for joining us to discuss the meaningful steps we have taken to remove U.S. pension volatility and accelerate the path of full removal. With the recent debt transaction, we have transformed our capital structure to continue the progress we have made over recent years in executing a strategy to reduce the size and volatility of our pension with the end goal of removing it from our balance sheet. The series of transactions we've just completed clears the way for both us and our investors to focus more squarely on operational performance without the ongoing distraction of managing volatility in the pension deficit and the corresponding contributions. While our U.S. qualified defined benefit pension plans are still underfunded, we have practically eliminated the volatility of our aggregate cash contributions related to market and interest rate movements down to 3% of what we're providing today. This marks a meaningful step forward in simplifying our financial profile and enhancing long-term visibility into future cash flows. Turning to Slide 4. I'll start by discussing our strategic capital structure objectives listed here. The actions we took in the second quarter were guided by these objectives. Some were achieved immediately while others require a little more time. We believe this creates a clear path to full removal of the U.S. qualified defined benefit pension plans and accelerates the time it takes to execute our plan. First, we've been very focused on reducing the size of the U.S. qualified defined benefit pension plans for many years now with the goal of removing it completely in a cost-efficient manner. Since the inception of our strategy, we have executed many pension risk transfer transactions, reducing liabilities by approximately $1.5 billion. Second, we're focused on creating more certainty in our future cash requirements, particularly as it pertains to our pension contributions, which have seen material fluctuation due to financial market volatility. We believe that this volatility has been a significant barrier to attracting new investors. Third, maintaining a solid liquidity profile with strong cash balances and having access to short-term borrowings through our asset-backed revolver are important elements for managing the peaks and troughs of working capital and mitigating risk from potential unforeseen pressures on the business. A fourth key objective is to reduce net leverage, which we believe will ultimately result in improved credit ratings and increased access to capital at more favorable terms. Fifth, although we would like to remove the pension as quickly as possible, we believe it's important to take a balanced approach in order to maintain debt capacity for growth opportunities. Finally, once these other objectives are met, we'd like to increase the attractiveness of the company to investors and expand our shareholder base by implementing a capital return program either through stock repurchases or a stock dividend. Turning to Slide 5. I'll summarize the key actions we've taken. First, we issued $700 million of debt maturing in January 2031. Most of the proceeds were used to refinance our pre-existing $485 million notes, which removed the near-term risk of accessing the high-yield markets, which can be very episodic. The remaining $200 million of proceeds, in addition to $50 million of company cash were used to contribute $250 million to our U.S. qualified defined benefit pension plan. Please note that this discretionary contribution is incremental to our 2025 planned contributions, which we expect to fund with cash generated from the business. We also amended our $125 million asset-backed revolver, extending its maturity to June 2030. The last element of what we've completed is to reallocate pension plan assets such that the movement in assets matches the movement in liabilities, practically eliminating the market volatility. Looking ahead and now that the volatility has been mitigated, our strategy will focus on liability removal through annuity purchases, which Deb will discuss in more detail. At the same time, as we make contributions, the deficit will continue to decline. These two components, total liabilities and deficit determine the ultimate cost of removal. The second of our next steps is to increase our capacity to fund the cost of removal. We currently expect to achieve this through a focus on increasing our EBITDA and generating excess cash. Turning to Slide 6. I want to quickly run through the benefits of the $700 million issuance and pension actions we've just completed and how that removes pension overhang in near term while advancing us towards the goal of full removal. First, I want to reemphasize that the $250 million contribution combined with recent changes to our U.S. investment strategy removed substantially all volatility in total contributions projected for the next five years. Deb will discuss in a moment how our asset allocation has changed and how this factored into the timing of our issuance. Second, the onetime contribution brings our funded ratio above thresholds that are required for continued annuity purchases which, as I mentioned, are an important part of the next phase of our strategy. This represents a continuation of the strategy that brought us to the point that allowed us to carry out this transaction. We expect to remove additional liabilities of approximately $600 million through annuity purchases by the end of 2026, removing approximately 1/3 of the remaining U.S. plan liabilities. Another benefit of our transaction is a meaningful reduction of both U.S. GAAP deficit and future contributions. The $250 million incremental contribution we made reduces the pension deficit dollar for dollar, which keeps the transaction roughly leverage neutral and significantly lowers projected contributions between 2026 and 2029. Importantly, this is cash flow accretive over the next five years because contributions have come down by more than the interest on the incremental $200 million of debt we issued. We have included detailed calculations of the post-transaction deficit and contributions later in the presentation. And again, the aggregate contributions will have minimal volatility going forward. Lastly, we expect this transaction will enable us to fully remove our U.S. qualified defined benefit pension plans in the next 3 to 5 years as we execute on the next steps of reducing the cost of and increasing our capacity to fund full removal. We hope that this session provides a deeper understanding of what we've achieved and where we expect to go and that it charts a clear course to putting our pension exposure fully behind us in a relatively short time while not overlevering the company. This reflects a commitment to protecting financial flexibility and creating long-term value for our shareholders. I'll now turn it over to Deb to discuss some specifics around the new debt and the analysis supporting these transactions, which is really the culmination of years of planning and execution that the team has put in to mitigating the pension.

Thank you, Mike. We truly believe this is a transformative change, which will result in a stronger company and increase flexibility going forward. Turning to Slide 7. I won't go through all the terms of the new debt in detail, but I do want to highlight the redemption terms. During the non-call period, we have the ability to pay up to 10% of the debt, approximately $70 million every 12-month period at a redemption price of 103%. It's important to note that the analysis on the following pages does not assume any early debt repayment or additional discretionary pension contributions. However, with excess cash available, having the flexibility to either reduce debt and/or further fund the pension plans provides meaningful upside. These options will make the financial outcomes, we'll review in a moment even more favorable. Turning to Slide 8. The initial overall impact of these actions is largely leverage neutral. Just a quick note, as we haven't reported our second quarter results, the table on this page and my commentary reflects values as of March 31, except for pension deficit figures, which are as of year-end 2024. Gross leverage declined slightly driven by the use of balance sheet cash for the pension contribution. On the other hand, net leverage increased modestly due to transaction-related fees. Importantly, our liquidity position remains strong with a cash balance of over $300 million and full availability under our $125 million asset-backed revolver. Turning to Slide 9. This slide outlines the recent changes we've made to the U.S. pension plan investment strategy, changes that are expected to significantly reduce volatility in both contributions and deficits going forward. Historically, the plan maintained a 65% allocation to growth assets which introduced considerable asset volatility. Under the new strategy, we've retained a modest allocation to growth assets for diversification, but the portfolio is now structured to hedge liability movements. Importantly, the risk premium associated with growth assets has declined in recent years, making this an opportune time to derisk the investment strategy as the spread between the return we can secure and the expected return at our previous asset allocation has narrowed. This was an important factor considered as we timed our issuance. While this shift does result in a lower expected return, which may result in a modest increase to the contributions in the years following 2029 compared to prior estimates, we expect to fully remove the U.S. plans within the next 3 to 5 years subject to market conditions prior to reaching those outer years. Turning to Slide 10. This slide illustrates the cash flow benefit of raising an additional $200 million and using $50 million of balance sheet cash to fund the discretionary contribution to the pension plans. As a result of this contribution, required contributions to the U.S. plans are expected to decline by approximately $165 million through 2029. Offsetting this, the incremental interest expense on the $200 million of new debt along with the lost interest income on the $50 million of cash is expected to total about $95 million. This results in a net cash benefit of roughly $70 million through 2029. And importantly, this benefit could increase further if we choose to use excess cash from operations to either pay down the debt and/or make additional pension contributions. With the volatility reduction, we have achieved by changing the asset allocation, the aggregate expected contributions through 2029 could shift from the forecast on this page by about 3% in aggregate, though there could be some additional movement between years. Turning to Slide 11. We've outlined the projected cost of fully removing the U.S. pension plan by 2029. This projection includes an assumed annuity purchase premium of 10% to 15% over the accounting liability. For context, our historical annuity transactions have averaged a premium of just 3%. So if we're able to continue executing annuity purchases over the next five years at or near historical levels, there's a significant opportunity to reduce the total cost of full removal of the U.S. plans. This underscores the value of our proactive annuity purchase strategy to reduce the cost of full removal of the U.S. plans. Turning to Slide 12. This slide summarizes the multiple benefits of the transformation we've been discussing and the key points we hope you take away from today's discussion. While the transaction is clearly cash flow accretive, the real value lies and the impact on the pension plan. By significantly reducing the volatility around both contributions and the deficit, we've created a more stable and predictable financial profile. We believe this positions us well for continued progress towards fully removing the U.S. plans while maintaining strong financial flexibility. With that, I'll turn it back to Mike, and we can take questions.

Great. Thank you, Deb. Operator, please open up the line for questions.

[Operator Instructions]. And the first question will come from Rod Bourgeois with DeepDive Equity Research.

Thanks for this update and the details here. I have a scenario question to start with. Going forward, if there were to be the same type of extreme interest rate moves as occurred in 2022, what would volatility in your contributions look like in that kind of extreme scenario, would the maximum volatility still be around 3%, even in that extreme situation?

Thank you for the question. One of these days, we'll get your last name right, as Bourgeois, but we'll get there eventually. And I love how you -- we start off with the softball question. So thanks for that. You always have the good one. That's for sure. Great question and I'm glad you asked it. It's super important to -- so I'm going to try to answer it plainly, and then I'll give a little more color. And if you want me to dive in even further, we can do that as well. The short answer is no, we don't believe the volatility will be affected by the market movements that we've talked about. And I think it's important that we understand what happened in '22 and that will help explain how we've mitigated that currently. So really what happened in '22, and I know you know this, but for the audience here, we essentially had an increase in our contributions of about $800 million. And that was really related to the 25-year average interest rates that are used for funding purposes. And so we saw a significant rise in interest rates, as you've indicated, from a market perspective. We are now doing our forecasting on market-based rates as opposed to the 25-year average for that. And we've also seen, and it's really part of the process here, when we saw that movement in rates, essentially, what that does is it creates a distortion between the rate used for forecasting purposes in the contribution schedule as opposed to the real interest rate. And so the fact that we were able to kind of understand that, that was the implication of it. We looked at the movements to market rates, and we're really timing the reduction of the risk transfer rate. So when you look at our, our return on assets, there is a portion of our assets that are really tied into the equity side of the portfolio, which is our risk return. And the spread there has tightened considerably, right? So we're only about 2 basis -- 2 points away from our fixed rate return versus our equity rate return. So moving all of those assets over to fixed rate, ensuring that we've got a matching between that asset portfolio of assets and liabilities and changing the plan, so that it's moving at market rates. You have a balance between the asset return and the movement in the liability and by shifting all the assets into fixed, you eliminate the possibility for that kind of volatility to happen in the future. So in order to do that, we also needed to put an infusion into the plan, which is why we borrowed the additional $250 million. So putting that $250 million in, increasing the assets in the plant, shifting all the assets over while we saw that reduction in the risk-related returns and an increase in the fixed component allows us to mitigate that volatility from a future rate perspective. And so I think and being able to get the additional $250 million, obviously had to be tied into the timing of the high-yield markets being available to us, being available to upsize and doing it in a period where we weren't going to pay a premium or a penalty for refinancing early. So we had a bunch of different market conditions that we had to wait for in order to execute this plan. And in the interim, as you know, we've removed over $1.5 billion worth of gross liability from the plan. So the fact that the plan is significantly smaller, the deficits significantly smaller that reduces the exposure. And now the assets all being in fixed income reduces the volatility. And so look, I'll commend the team for their continued effort that we've put in over the course of the last three years, waiting for these conditions to be in the right that we could execute this. And when the conditions were right, we basically executed it flawlessly. So really happy with the team's performance and really happy that we've removed the volatility from the plan. We do not believe it can extend in the aggregate greater than that 3%.

This is Deb. Yes. Just a quick clarification, we borrowed an incremental $200 million and used $50 million of our cash on hand. So just a quick clarification. But thank you for the question. And I didn't mean to interrupt. Go ahead.

No, no problem. That's just an impressive technical details on pension coming from a CEO. Am I 25 years of asking CEOs questions. I think that might have been the most technical detail in terms of an answer. Listen, on that note, Mike, a big picture question, right? You've been working on this pension strategy stuff since I think even before you were Unisys's CFO a number of years ago. So I just want to ask your overall take on what this pension news means for you and Unisys? In other words, what's the most important thing that you see stemming from this transaction when the company goes forward from here?

Yes. Thank you, Rob, for that, and thank you for the kind words. Look, this is something we've been working on for a long time. It's been a significant overhang from the company's perspective. We have definitely seen and heard from equity holders that the complexity and valuing the company and valuing this pension was barrier to increasing the share participation in the stock. So I think it marks really a tremendous upside from the company perspective. It really, again, solidifies our position. I hate to say it in this manner because it's never autopilot, but it's basically going to be on autopilot. We'll continue the annuitizations as we talked about during the plan here to continue to mitigate any future exposure as far as the full remediation of the plan. By my calculations with the $1.5 billion that we've already taken out and the anticipated $600 million that we're targeting, that would allow us to remove this plan at about $200 million, $210 million less of cash out the door to get this off our books. So it has taken a tremendous amount of time, effort, management thought process, et cetera. And I think this really just allows us to focus 100% on the business and hopefully allows the investor community to really focus 100% on the business. But -- so I think it's really a milestone for the company, and I'm thrilled to be part of it.

Your next question will come from Anja Soderstrom with Sidoti. Your next question will come from Arun Seshadri with Forza Investment Group.

Just a couple of questions from me. Try to understand the -- have you put in anything in place today that allows mechanically for the removal of the U.S. DB in 2029? Is there something specific that you had to do? And then secondly, the capital return program that you talked about potentially either buybacks or dividends. Is that, I guess, following the retirement of the U.S. plants.

Great. Thanks Arun. Appreciate the questions. I'll do the second one first because it's a little more direct. Yes, it is following the retirement. Look, we've always said that we wanted to be on this kind of path to normalcy as it pertains to our capital structure and the like. Many of our competitors obviously have one or more of those types of programs. We think that's an important element to ultimately attract new investors to the stock. And so that's something that we wanted to make sure we were clear about that is in our future road map, but it is post us essentially taking care of the pension obligation. As far as your first question, the mechanics to do that is really just the passing of time and the execution of our existing planning structure, right? So there's nothing specific that we have to do from a mechanics point of view to execute in that time frame other than to continue what we've been doing. So again, we mentioned the annuity purchase programs that we're looking at over the course of the next I'll call it, two years, that $600 million takedown. Everything we do in that at the -- average of 103% that Deb talked about earlier on the call, is 10% to 12% better than a full annuitization would be. So we'll continue down the path. We've been on -- we'll get that to a point where it's a manageable value, and then we'll execute the transaction to remove it from our books. But there's nothing else that has to happen from a mechanics point of view for us to execute that.

And then on the new, I guess, the sort of restructured profile of the assets, what is the duration or the average duration of the treasury and the corporate bond portfolio that you've used now? That's all I had.

Yes. Deb, do you want that one?

As far as the duration of the new -- the planned liability duration is about 7 years, and bonds are similar to the liabilities.

Your next question will come from Anja Soderstrom with Sidoti.

Can you hear me now?

Yes, we could hear you.

I'm sorry about earlier. Thank you for making this call. First, I'm curious about if you could talk about how you approach the decisions of when to time this transaction and what the optimal size of the deal in contribution was?

Yes. So the timing actually was kind of tied into the dialogue that we have with Rob's question as well on you. So essentially, we needed a couple of things to happen, right? We needed to have that spread ultimately shrink between the rate premium for the risk assets and the increase in the fixed assets. We needed the timing of the debt to be aligned to our ability to refinance, because we would have had to do that to upsize. And thank you, Deb, for the clarification on the upsize there to get that additional $200 million in. And then -- because we needed to make that additional contribution to that asset before we could shift those assets over from a fixed perspective. So there were a handful of, I'll say, technical barriers from a timing perspective, and we needed to wait for that alignment to happen to execute. The $250 million, which was made up of the incremental $200 million that we borrowed plus $50 million of cash off our balance sheet. All of our modeling told us kind of the sweet spot on the contribution was between $250 million and $300 million. And so we are really just waiting to see what the rate structure would be on the new debt to determine how much we wanted to actually incrementally borrow to do that and the other little nuance there is anything we had to contribute at least 200 to get our funded status up in the plan, so that we can continue the annuitization program. So the size was really dictated by how much on the annuitization program, how it balanced our overall cash contributions over the next five years. We knew it was going to be between the $250 million and $300 million, and then the determination to go from a contribution of $250 million or the extra borrowings of $200 million was really going to be rate determinative as to what the market would bear.