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An Open Client Edition
Analysis of Electronic Data Systems’
Third Quarter Business Results
Pain Without Gain
Big Charge ($2.24 Billion) Dominates Earnings News; New Contracts Up
October 29 – “No
pain, no gain,” is what doctors usually say when trying to justify a
radical medical procedure. But
what if it turns out to be “pain without gain?”
that just about sums up what the Electronic Data Systems’ (EDS)
shareholders and employees have been through during the first nine months
of 2003. The $2.24 billion
accounting charge, announced Monday, quantifies the amount of pain
they’ve had to endure.
As a result, EDS has now lost $1.3 billion to-date in 2003, as compared to a $755 million net profit during the comparable period last year. It has announced work force reductions of 5,200 people, or 4% of its total employment. And it has posted a negative free cash flow of $303 million, versus a positive $110 million a year ago.
may be worthwhile remembering that the year ago quarter, which now looks
relatively good by comparison, was actually the period when wheels appear
to have come off the EDS cart – see Wall
Street Legal Vultures Descend Upon EDS, Sep 27, 2002, and
Issues Earnings Warning, Sep 18, 2002).
thing is for sure… EDS’ shareholders and employees deserve high marks
for pain tolerance and are entitled to some powerful painkillers.
Oddly enough, a street that has not been exactly known for awarding masochism did just that. The day EDS announced its “megacharge” (Monday), the company’s shares rose 1.8% to $20.97. The stock continued to climb (to $21.85) before today’s earnings release. And it went up to $22.10 in after-hours trading.
despite all the pain and red ink, the EDS stock has outperformed both the
market and its chief competitor (IBM).
And not just in the last few days, but also during the last six
months (see the chart on page 2).
so much for pain. What about
gain? There is some good news, although one has to dig deep to find
13% increase in third quarter new contract signings is one bright spot.
The 6% increase in revenue is another, especially considering the
7% decline in GM business.
But the revenues would have dropped 2% as reported, prior to the new EITF-00-21 accounting rule.
Furthermore, the 2004 revenue may decline by at least $1.4 billion unless EDS recharges its sales engines and reverses its declining new contracts record. The new contract signings for the first nine months were down 41% ($9.7 billion vs. $16.4 billion).
that the new contract sales end up down $10 billion in 2003, and given a
seven-year average contract term, the annual negative revenue impact would
be about $1.4 billion. Of
course, that’s before any expirations, cancellations or “rescoping”
– all of which could only exacerbate the EDS growth challenges).
EDS CEO Michael Jordan, and the CFO Bob Swan, who fielded questions during
the post-earning analyst teleconference, agreed with the above logic and
math. And they admitted that
the company’s results during the first three quarters were
of (new contract) signings continues to improve… (but the) quantity (is)
still problematic,” Swan said, referring to an earlier comment by the
EDS CEO about the company’s “improving win rates.”
executives also acknowledged that they expected “no dramatic growth”
in the sales pipeline. Answering a question by an analyst, they said that future new
contract sales growth would come from better win rates, rather than bigger
Ouch… For, that implies the market or opportunity is flat or shrinking. Which may be the way EDS executives see the world, but is clearly NOT the case when it comes to their competitors.
you saw in our recent report on IBM Global Services’ third quarter
results, its contract sales were $15.4 billion, the best ever for the
third quarter. The backlog
was also up, from $112 billion to $115 billion, the highest it has ever
been (see “Small
Is Now Big at Big Blue,” Oct 16).
month or so before IBM released its latest results, Accenture reported a
34% jump in its quarterly new contract signings, finishing the August 31
fiscal year end with a $16.1 billion total (see “Strong
Finish,” Sep 18, 2003).
Hewlett Packard Services is due to report its latest quarterly results next month. Early indications are this competitor is seeing no slowdown in demand, either.
Fixing What’s Not Broken
the EDS problems are indigenous, not IT services industry or
macro-economic in nature. Given
that, to what end, we wondered, did the company choose to add to
its pain by performing such elective “surgeries” as the
EITF-00-21 accounting change?
wanted to ask the EDS CEO that question during the analyst teleconference
that followed the release of EDS’s third quarter results.
But we never got a chance. So
we posed the question afterward in a phone call to Myrna Vance, EDS’
director of investor relations.
said that EDS wanted to get its cost structure under control, which would
make it more competitive with its rivals.
But we pointed out to her that EDS is already by far the leanest
competitor among the top IT services vendors.
And that it has been winning gold medals for frugality in our
annual IT Services Heptathlons for years (with an SG&A
expense-to-revenue ratios in the 9% range - see “2003
IT Services Heptathlon,” May 2003).
EDS’ Jordan said today that his goal is to have a 7% SG&A
us, it seems that EDS is trying to fix something that isn’t broken.
Instead of adding to the sales firepower in order to grow the
business, it is reducing it. That’s
like rationing ammo to poor marksmen, or removing radars from airplanes
and X-rays from hospitals in order to cut costs.
does seem to be broken at EDS, however, is its low gross margin.
which is what it was in the
latest quarter, it is up from 9.8% a year ago (restated).
But both figures are pitifully low compared to IBM’s 25% gross
margin in the latest quarters, or Accenture’s 36%, for example.
means that EDS is either pursuing too many big deals where price
competition is intense and margins are low, or is discounting its prices
across the board. Or both.
Whatever the problem, the solution seems to selling smarter,
not cutting costs. What EDS
needs to do is develop new and different markets which would yield higher
profit margins, not gloat over improving win rates with customers that are
already bleeding EDS sales people dry.
EDS “Pruning” Again
Vance also said that EDS has been working hard on “tackling the problem
We reminded her of our story from July 2000 about all the
“pruning” of such problem contracts that the previous EDS management
We even did a photo-cartoon for the occasion (see “EDS
Contract Pruning,” July 2000):
Over half a billion dollars in revenues is a
heck of a lot acreage being “pruned.”
Millions of companies would “kill” for the privilege of being
able to grow to the size of the limbs EDS has been severing.
Yet in the global IT services business jungle,
eliminating low-margin or unprofitable contracts may be even more
important for EDS’s long-term longevity than slashing costs and
expenses. It’s kind of like
getting rid of bad blood - the medieval doctors’ remedy “for all
patients and all seasons.”
Still, more than $500 million in revenues is a
heck of a hole to fill with new business just to be flat with prior
year’s results… This was no “pruning.”
This was evidently a long overdue “slash and burn” activity.
what happened?,” this writer wondered.
“I thought after all this ‘pruning’ over three years ago, you
wouldn’t have any ‘problem contracts’ left anymore.”
replied that regrettably, the company had slackened off in this respect.
And so here we are… “pruning” again.
But she added that the company has been winning some major new
contracts with more to come.
the third quarter, the biggest percentage of new contract signings came
from the U.S. government, which accounted for 41% of the total ($3.4
As with EDS’ major competitors, in today’s global war economy,
selling to the federal government appears to be the best bet.
Manufacturing sector came second with 20% share of new contracts,
with communications accounting for 11% of the total.
Meanwhile, back on the (Plano, Texas) ranch,
the Americas and Asia/Pacific regions contracted in the third quarter,
while the U.S. government and European business surged ahead. America’s
revenues were down 3% in constant currency to $2.28 billion, while the
region’s operating profit dropped 34% to $223 million.
As previously noted, the U.S. government
revenues were up 39% to $790 million, while its operating profit jumped
195% to $29 million.
revenues grew 4% in constant currency during the third quarter, while the
operating profit on the Old Continent surged 563% to $152 million.
The Asia/Pacific revenues contracted 10% in
constant currency to $246 million, while its operating profit jumped 29%
to $12 million.
Lines of Business
Meanwhile Among the EDS lines of business, an organizational structure left from the previous administration that the new EDS management has now virtually abandoned, outsourcing continues to grow in double digits (up 11%), while AT Kearny (consulting) continued to shrink, also in double digits (down 26%).
Business Process Outsourcing (BPO), a relatively new concept in
outsourcing in which some EDS competitors, like IBM and Accenture are
thriving, grew by a modest 4%.
The BPO sub-segment now represents about 13% of EDS’ revenues,
with the IT (traditional) outsourcing accounting for 56% of the total.
there are some signs of a gradual recovery evident in the third quarter
results, EDS clearly has a long way to go before one can declare that the
turnaround is under way. The
company’s biggest challenge continues to be increasing new contract
sales at higher gross margins than what the company has managed so far
costs won’t increase revenues. EDS
needs new sales leaders who will inspire its own troops and imbue its
customers with confidence to do business once again with the company.
And it needs to look beyond traditional customers to find new
markets and opportunities for profitable growth.
do that, however, it needs the kind of leaders who share that kind of a
vision for the future of the company.
bargain hunting! Bob
Happy bargain hunting!
 EDS implemented this year new accounting rules governing when revenue is booked on long-term contracts. In the past, EDS booked a percentage of revenue it hadn't received to offset start-up costs, with the assumption the cash would come in later. Now, EDS will book most revenue as it is received. The approach, which more closely matches revenue and cash flow, is expected to shift revenue to future quarters from earlier periods, benefiting future earnings.
For additional Annex Research reports on EDS, check out...
2003: Pain Without Gain (Oct 2003), EDS CEO Replaced (Mar 2003), Rebuilding Trust and Confidence (Feb 2003)
2002: Wall Street Legal Vultures Descend Upon EDS (Sep 27, 2002), EDS Issues Earnings Warning (Sep 18, 2002), Wall Street-Main Street Chasm Widens (July 3, 2002), Analysis of EDS 4Q01 Results (Feb 8, 2002)
A selection from prior years: Annex Research Analysis of EDS 4Q00 Results (Feb 7, 2001), EDS Takes Over US Navy (Oct. 10, 2000), EDS Second Quarter Results (July 28, 2000), Annex Bulletin - 2000-02 (EDS' e-Price Clubs).
Volume XIX, No. 2003-18
Editor: Bob Djurdjevic
P.O. Box 97100, Phoenix, Arizona
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