Navy Contract Hurts EDS's Bottom Line

The IT services firm posted a 4Q loss of $354 million after writing down the value of a contract to build a communications contract for the Navy and Marine Corps.
PLANO, Texas (AP) -- Electronic Data Systems Corp. swung to a loss of $354 million in the fourth quarter after writing down the value of a big contract with the Navy that the company is trying to renegotiate.

EDS said Thursday it lost 74 cents per share compared to a profit of $360 million, or 75 cents per share in the last quarter of 2002.

The technology services company said it wrote down $559 million in deferred costs on a contract to build a communications network for the Navy and Marine Corps. The contract, originally valued at $6.7 billion, is far behind schedule because of technical challenges that caught EDS by surprise.

Without the write-downs for the Navy deal, $84 million for restructuring costs and $7 million in losses from discontinued business, EDS said it would have posted an operating profit of $59 million, or 12 cents per share. On that basis, analysts surveyed by Thomson First Call had forecast profit of 11 cents per share.

Revenue in the October-December period rose to $5.76 billion from $5.47 billion a year earlier.

New contract signings, an important gauge of future revenue, fell by nearly half, to $4.3 billion in the fourth quarter from $8.1 billion a year earlier.

EDS said it expected earnings in the first quarter, excluding losses on the Navy deal, of 15 cents to 20 cents per share, which is in line with analysts' forecast of 16 cents per share, on a 5 percent drop in revenue. The company said 2004 revenue would be about flat with last year.

Chief financial officer Robert Swan said the company would lose about $250 million on the Navy deal this year and begin making money on it in 2005--about a year later than previously projected.

EDS officials said they are renegotiating the deal to reduce the amount of money it will spend upfront--but also generate lower revenue in future years. Swan said EDS will generate about $1 billion in cash flow over the life of the contract instead of the original goal of $1.9 billion.

Cynthia Houlton, an analyst with RBC Capital Markets, said there was no guarantee that the Navy will go along with EDS's plan to slow down the project to save the company money in the short term.

"This helps EDS, but there's no benefit for the Navy," Houlton said. "They are making assumptions that the Navy hasn't finalized."

Although EDS beat Wall Street's estimate for operating profit, some analysts panned the fourth-quarter results.

"We were expecting a weak quarter and it was worse than we anticipated," said Natalie Walrond of Pacific Growth Equities. She noted that the company scaled back its estimate of free cash flow in 2004 from between $600 million and $800 million to between $500 million and $600 million.

Walrond said she worried that any further setbacks in the Navy contract or other big deals could lead to a reduction in EDS's debt ratings.

Late Thursday, rating agency Standard & Poor's cited the lowered outlook for free cash flow and trouble with the Navy contract in placing EDS's corporate credit and senior unsecured debt ratings on a credit watch with negative implications--a possible precursor to a downgrade. Those ratings are currently two notches above non-investment grade or junk status.

EDS, which announced 5,200 layoffs last year, has struggled to win new contracts while losing money on some of its existing work, including the Navy deal. In December, the Plano, Texas-based company missed out on a potential $5 billion contract when it was replaced as the technology vendor to the U.K. tax agency.

Chairman Michael H. Jordan, who has hired several new top executives recently, said Thursday the company has adopted a more predictable timetable for the Navy deal.

"We are continuing to put EDS's house in order," Jordan said.

EDS has often been credited with inventing the business of running other companies' computer systems. Last month, officials charged with reviving the struggling company said EDS would offer more sweeping advice to customers, including help in running personnel and finance operations.

For the year, EDS lost $1.70 billion, or $3.55 per share, compared with a profit of $1.12 billion, $2.28 per share, in 2002.

Revenue in 2003 grew slightly to $21.48 billion from $21.36 billion in 2002.

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