Battling controversies, EDS readies Q2 report

Electronic Data Systems Corp.'s quarterly financial report Wednesday is highly anticipated because the company has grappled recently with various controversies that have bruised its image and its stock price.

Exasperated company executives have repeatedly said the issues have been blown out of proportion, that EDS remains financially solid and that the quality of its services hasn't been affected, claims analysts generally concur with. The second-quarter report is expected to clarify further whether the recent bumps are in fact isolated or whether they are a sign of deeper trouble.

"It's a pivotal report," said Bob Goodwin, an analyst with Gartner Inc.'s Dataquest Inc. unit, who believes EDS remains a solid IT services provider. "They've been having some hiccups, but long term I'm still bullish on EDS."

As of Monday, the consensus from analysts polled by Thomson Financial/First Call is that EDS will post revenue of $5.4 billion and pro forma earnings per share of $0.76 cents, meaning one-time charges are excluded from the earnings forecast, according to a Thomson Financial/First Call spokesman. The company reported actual earnings of $0.62 per share and revenue of $5.1 billion in the second quarter of 2001.

Since January, EDS, the world's second-largest IT services provider behind IBM Corp.'s Global Services unit, has seen its stock lose over half its value -- dropping from $68.24 on January 2 to $31.59 on July 19 partly because investors have lost confidence in technology stocks but also because they reacted negatively to EDS problems such as the company's getting caught in the undertow of WorldCom Inc.'s tidal wave.

Because WorldCom awarded EDS an 11-year $6.4 billion IT outsourcing contract in 1999, some fear that EDS' bottom line could be affected by the financial woes of the telecom giant, which filed for bankruptcy Monday. EDS says it will not be crippled financially should its contract with WorldCom die an early death. Other concerns center on service disruptions, since EDS chose WorldCom as its preferred -- albeit not exclusive -- telecommunication service provider under an 11-year $6 billion contract. WorldCom provides services to EDS for its internal operations and to EDS clients. EDS maintains it has contingency plans in place to prevent service disruptions.

But an analyst cautions jumping to conclusions based on the beating EDS is taking on Wall Street.

"The stock price is not at all correlated to the company's ability to serve their clients," said Dirk Godsey, an analyst at J.P. Morgan Securities Inc.

"EDS is a solid IT services provider. It has performed very well in the past three years" especially in the outsourcing area, which is its specialty, said Lorrie Scardino, a Gartner analyst. EDS generates about 75 percent of its revenue from outsourcing work, according to the company.

EDS also gets high marks for its improved customer service, according to Christine Ferrusi-Ross, an analyst with Forrester Research Inc. in Cambridge, Massachusetts. "EDS has done a lot in the past year to renew its momentum," she said.

Analysts concur that as a result of the company's stock slump and string of public-relations snafus, clients should monitor EDS more closely than usual and make sure service quality doesn't slip. But clients have no reason to panic, analysts said.

"It's getting hammered ... but EDS is a sound IT services company that is focused on the right things," like customer satisfaction, the development of new services and the delivery of existing services, Gartner's Scardino said. "They get good feedback from clients we talk to."

It is particularly important for clients who receive WorldCom services via EDS to be in close contact with EDS, because EDS has failed to reach out to those customers to explain what contingency plans are in place in case WorldCom services are terminated or severely disrupted, Scardino said. "EDS clients see this (WorldCom situation) as a risk, as well they should," she said. "I've heard from a lot of their clients that EDS hasn't been proactive about this, and I find that disappointing."

Other issues 40-year old EDS has had to address recently include:

-- Several press reports over the past 7 months have raised questions about EDS' accounting practices, although the company denies any impropriety and hasn't faced any accounting charges nor starred in an accounting scandal.

-- Its eyebrow-raising decision a few weeks ago to pull out from a gigantic outsourcing Procter & Gamble Co. bid, which some saw as a troubling sign, but which EDS executives maintain was a good decision because the requirement that the winning bidder make a substantial financial investment wasn't in EDS' best interest.

-- Delays, technical problems and close monitoring from Congress in EDS' multibillion dollar U.S. Navy outsourcing contract.

-- The continued slump in demand for IT services and drop in IT services prices, something affecting not only EDS but also its competitors, and a factor in EDS' decision earlier this month to lay off about 2,000 employees or 1.4 percent of its workforce. The market slump also caused it to fail to meet revenue expectations in the first quarter, when it also saw its net income drop compared with last year's first quarter. In May, Dataquest predicted that the IT services market would grow a tepid 2.8 percent in 2002 compared with 2001. "It's a tough market. I don't think we'll see some loosening until well into 2003 in IT services," Gartner's Scardino said.

On July 2, after the WorldCom scandal had claimed EDS' stock price as one of its victims and after a New York Times article shone light on EDS accounting practices the newspaper called "intriguing" in its headline, EDS' top executives held a hastily arranged press conference with financial analysts to do damage control.

"We've been buffeted by rumor, speculation and innuendo," Chairman and Chief Executive Officer Dick Brown said. "We're putting a stake in the ground today to lay out the facts clearly and crisply, to put speculation aside and deal only in facts."

Although the briefing seemed to calm financial analysts, EDS was once again last week dealing with yet another pie in the face, and yet again cried foul. The Texas attorney general released a report saying an EDS subsidiary had overcharged the state's Health and Human Services Commission in an outsourcing contract to process Medicaid claims.

EDS subsequently put out two statements last week regarding the issue, saying the problems highlighted in the report are old and known and were all either already solved or being addressed by EDS before the report came out.

In a sign of a company saturated with bad publicity, EDS defended itself using uncharacteristically strong language in the statements, calling the report "fundamentally flawed, biased and politically motivated" and quoting an EDS executive as saying: "We are tired of having EDS' reputation demeaned by a whisper campaign of rumor, false accusations and half-truths."

Analysts interviewed are generally giving EDS the benefit of the doubt in these controversies.

They concur that the bumps in the Navy contract, valued at $6.9 billion and awarded in October 2000, are not out of the ordinary in projects of that magnitude. "They've run into the normal setbacks (encountered) when doing something new and big," J.P. Morgan's Godsey said.

"Overall, EDS has done what it has been asked to do, and has worked well with (the Navy's group) to keep the program on track and to fix lot of the technological and communications issues that have been raised by users and Congress," Scardino said.

Analysts also say EDS did well to steer clear of the Procter & Gamble project once it became clear how much of an initial investment the winner of the bid will have to make, considering EDS is trying to strengthen its cash flow. Gigantic outsourcing contracts drain a lot of money from the provider in the first few years as the project ramps up. J.P. Morgan's Godsey estimated in a research note published in early July that the contract's winner will have to invest at least $1 billion to acquire Procter & Gamble assets. "EDS is being very clear about not getting involved with any deal that requires more cash and upfront investment than EDS can comfortably" put up, Gartner's Scardino said.

Meanwhile, J.P. Morgan's Godsey says EDS' accounting methods are not only consistent with those of other major companies in the sector, but actually lean towards the conservative.

Overall, "I give them a cautious thumbs up," Dataquest's Goodwin said.

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