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2 Oct 02. The FT reports today from San Francisco that Electronic Data Systems (EDS), the embattled IT outsourcing company, is considering trying to renegotiate the landmark $6.9bn contract with the US Navy that has become a big drain on its cashflow.

The contract, along with a $2.5bn deal to run part of the IT systems for the UK’s Department for Work and Pensions, has put pressure on the company’s finances at a difficult time, particularly after it was forced to pay out $225m last month over a failed derivatives hedging strategy. The US Navy deal is EDS’s biggest government contract and was a coup for the company when it was signed in October 2000. But EDS has still not received any money from it, despite facing significant costs, as a result of delays imposed by Congress.
Without the two US and UK government contracts, EDS’s free cashflow in 2001 would have been $900m larger, and in the first half of 2002 would have increased by $630m.

EDS’s cash position has also been significantly weakened this year because of the impact of two large bankrupt customers, WorldCom and US Airways, in addition to lower income from a large drop in spending by its customers. A surprise profits warning from the company, as well as the news of its derivatives loss, have now become the subject of an informal Securities and Exchange Commission inquiry.

Jim Daley, chief financial officer at EDS, said there was a “possibility” that the company would seek to renegotiate the Navy contract. Congressional requirements for testing the systems set in place after the contract was won had resulted “in significant build-up in unbilled receivables at the company”, he said.

The Navy said it could not judge whether EDS had the right to renegotiate the deal without a clear idea of the grounds, but added: “Any company can always come back to the government and ask.”

The government testing requirements have delayed the project by about 18 months. EDS has invested more than $640m in it with no return, and expects the deal to be cash flow positive by some time next year.

The pressure on EDS’s cashflow caused by the high early costs associated with big deals such as those for the Navy and UK government has led some analysts to question whether the company will be forced to scale back its ambitions.
However, Mr Daley said the company did not face any liquidity crisis. Dick Brown, chief executive of EDS, said that, despite the company’s recent setbacks, “there will be no change in our business strategy, we will still pursue mega deals”.

Even though income from the US and UK contracts has been delayed, EDS has already booked substantial amounts of revenue from the deals.
In the first six months of this year, the company said it recorded $731m of revenues that it had not yet billed, most of it relating to the US Navy and UK contracts.

The company defended the accounting practice, which it said it was required to follow under US accounting rules.

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