Earnings outlook slumps EDS

Shares of Electronic Data Systems tumbled as much as 11 percent today as investors remained skeptical that the world's largest computer services consultant can quickly recover from its weak first-quarter results.

EDS is facing the double whammy of having to find a way to cut costs deep enough to offset declining revenues while anticipating higher expenses as it refocus the business.

Investors, who have watched the company since spinning out from General Motors in 1996 when its stock traded at a five-year peak above 60 a share, have heard EDS give a range of reasons from quarter to quarter as to why it fell short of business plans, analysts said. Skepticism reigns as the company looks to move forward to pushing its stock above its trading range in the high 30s.

The company, which reported its first-quarter results after the market's close yesterday, posted revenues of $3.94 billion, up slightly from $3.6 billion a year ago.

Excluding acquisition charges, EDS reported operating profits of $211.3 million, or 43 cents a share, compared with $194.1 million or 39 cents a share a year ago. Wall Street had expected the company to post earnings of 44 cents, according to First Call.

But analysts note that EDS's operating performance was much lower than 43 cents a share, based on their number crunching.

"I think they had a really bad quarter. They had a $40 million gain on the sale of an asset and other things. Although they make the argument that it's part of operating income, one can argue it's nonreoccurring income," said John Puricelli, an analyst with A.G. Edwards. "If you take out that gain, it would give them an operating income of 37 cents, not 43."

Executives with EDS were not immediately available for comment.

The company warned yesterday that its financial results during the first half of the year might suffer as it continues to resolve certain contract issues with customers.

"First-half results, as anticipated, should reflect ongoing remediation of a small number of contract issues identified last year, as well as our continuing transition to the new terms of our contract with General Motors, our largest client," the company said.

However, analysts said EDS's poor first-quarter performance should have been avoided to some degree. The company has known since last year that GM, starting this year, would be able to get discounts on EDS service and that it would be free to open up bidding on $200 million worth of work each year to competitors. That $200 million, however, represents a small portion of EDS's overall GM business.

"I'm surprised that this caught them off guard and that they didn't adjust their costs down to factor in the discounts they would give GM," said Moshe Katri, an analyst with UBS. "They said it will take two or three quarters to adjust their cost structure down so there will be less pressure on their [profit] margins."

EDS's revenues from their GM contracts declined 2 percent in the first quarter; the company expects that to fall by the double digits for the year, Puricelli said. The automaker accounts for about a third of EDS's business.

In addressing EDS's relationship with GM, Puricelli added: "They're trying to run the 100-yard dash with a 50-pound weight on their back, and it's hurting them."

Meanwhile, when GM put $200 million of its business out to bid this year, competitor Computer Sciences Corporation snagged 10 percent of those funds. EDS, however, has said it has won 50 percent of the GM business, but the company did not disclose the dollar value of those deals, according to Puricelli.

EDS has indicated it expects higher general and administrative costs this year than a number of analysts had expected. Those higher costs, combined with declining revenue from GM, is expected to present a weak financial picture for the company in the near term, analysts said.

"They are investing heavily on expanding their skill capability," Katri added. "They've primarily been an outsourcing business. But competition there is increasing and hurting [profit] margins. So now, they are focusing on IT consulting, software development and ERP [enterprise resource planning]."

EDS will have to aggressively recruit employees to take them into these markets, hence driving up their expenses. Customers are wanting companies like EDS to offer specialized services, rather than be-all deals, analysts said.

"The contracts will be smaller and they'll have to go out and get more as a result, but they'll also be more lucrative," Katri said.

EDS said it won $2.4 billion worth of new business during the first quarter.

The company is going up against IBM and Hewlett-Packard, which have an advantage in bundling their services with their hardware. EDS also competes against Computer Sciences.