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Electronic Data Systems Corporation (NASDAQ:EDS)

Q1 2007 Earnings Call

May 03, 2007 5:00 pm ET

Executives

Dave Kost - VP of IR

Mike Jordan - Chairman and CEO

Ron Rittenmeyer - President and COO

Ron Vargo - CFO

Analysts

George Price - Stifel Nicolaus

Bryan Keane - Prudential

Rod Bourgeois - Bernstein

Tien-Tsin Huang - J.P. Morgan

Julio Quinteros - Goldman Sachs

Adam Frisch - UBS

Joe Vafi - Jefferies & Company

David Grossman - Thomas Wiesel Partners

Gregory Smith - Merrill Lynch

Moshe Katri - Cowen & Company

TRANSCRIPT SPONSOR

Operator

Good afternoon and welcome to the EDS First Quarter 2007 Earnings Call. At this time, all parties are on a listen-only mode. (Operator Instructions). Also, today's conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the call over to Mr. Dave Kost, Vice President, Investor Relations. Please go ahead, sir.

Dave Kost - Vice President, Investor Relations

Thank you very much, Ray. Hello everyone and welcome to our first quarter 2007 earnings call. With me today on the call are Chairman and Chief Executive Officer, Mike Jordan; President and Chief Operating Officer, Ron Rittenmeyer; and Chief Financial Officer, Ron Vargo.

You should have received an email from me with a copy of our press release as well as the presentation material to be used on today's call. I would like to remind you that the presentation along with the webcast are available on our website and will be archived there for the next 30 days.

The information covered on today's call which is not historical in nature, including statements regarding financial guidance or future financial performance and the value of our new contract signings constitutes forward-looking statements within the meaning of the Federal Securities Laws. These statements are subject to numerous risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from such statements.

For information concerning these risks and uncertainties, see the risk factors section of our most recent Form 10-K. We disclaim any intention or obligation to update these forward-looking statements whether as a result of subsequent events or otherwise except as required by law. In addition, we refer you to the slides posted on eds.com that accompany in this call. Amongst to other information, these slides and our earnings release present a reconciliation of the non-GAAP financial information to be discussed today and should be reviewed in connection with this discussion.

With that let me turn the call over to Mike.

Mike Jordan

Good afternoon and thanks very much for dialing in. Just a few highlights before we get into the details. First quarter '07 was a solid quarter its really shows the impact of good steady execution which was our major focus this quarter. Applications are showing significant signs of progress and as we have mentioned before that is consistent with our strategy of growing this part of our business. [When we were active] which you will see in our M&A thrust, we are continuing to work on major opportunities and that seems to be going well.

Financially we had a good quarter; revenue right on guidance at $5.2 billion. Our adjusted EPS of $0.31 and 5.1% operating margin are significantly higher than a year ago. That reflects some of the volatility we get in the low first quarter.

Free cash flow was a little bit disappointing driven primarily by working capital usage which will expect to improve throughout the year. Finally our TCV $3.4 billion obviously lower than last year and first quarter and also our fourth quarter '06, but on a rolling four quarters basis which is how we evaluate this. We believe we'll be solidly ahead and book-to-bill ratio greater than one which is our goal.

So now let me turn it over for the color commentary to Ron Rittenmeyer.

TRANSCRIPT SPONSOR

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Ron Rittenmeyer

Thanks Mike. As Mike said, total contracts signed during the quarter were $3.4 billion, down on some pretty tough comparables both year-over-year and sequentially you recall as we communicated we worked hard in the fourth quarter and successfully closed several deals in the fourth quarter earlier than we had originally anticipated, which drove a pretty strong fourth quarter and a full year 2006 TCV. And last year in Q1 signings of $10 billion included our landmark renewals for General Motors and the extension of NMCI. These two contracts alone totaled $7.5 billion. This quarter though we did sign seven deals with TCV greater than $100 million although none of those were really what we consider significant mega deals.

Significant signings in the quarter included contracts with for example, 7-Eleven, which is an applications and infrastructure management renewal, which extends our relationship through 2012, and Coca-Cola Finsa contract extension with the largest Coca-Cola bottler in Latin America. So, signings were well diversified across our product lines.

Applications, which sense they have that a lower TCV and a shorter contract duration did demonstrate particular strength with 34% of the contract of the total contract signings. Across to all of the vertical markets, government financial service and communications, we also saw reasonably strong signings. So all in all, signings were solid given the tough comparisons and we feel good about that.

On the next slide, we'll take a minute to talk about our outlook for year 2007. We are confirming our full year TCV guidance, a gain of $23 billion plus. The near-term pipeline is growing. There have been no material changes since we spoke with you back in February. We expect our backlog to continue to build as we progress the book-to-bill performance greater than one, which Mike just mentioned. Based on the makeup of our pipeline, we anticipate new logos to continue on the upward trend as well.

From a long-term standpoint, over the long-term our pipeline remains attractive with application services showing a marked increase from a year ago. And on a 12-months basis, our pipeline is up sequentially. There are few megadeals in the pipeline with most of the composition being primarily mid-sized transactions. We see opportunities in the major markets, the Americas, EMEA, as well as Asia-Pacific. And again, across all verticals, government, financial services really represent significant opportunities.

Next slide please. So let me take a minute and talk about applications. As we discussed during our Analyst Meeting in February, one of our key objectives in 2007 is to drive up the stack in applications during the quarter, our momentum towards this continued. First, application revenue is up almost 9% year-over-year, while signings represented over one-third of the total signings for the quarter.

Looking forwards that pipeline continues to improve both in quality and quantity, up about 43% versus a year ago. Secondly, strategic acquisitions complement our portfolio of offerings. We did finally complete the integration of our GEMS acquisition, which really strengthened our SAP capabilities and we recently announced our agreement to acquire RelQ, which is a leading India based software testing firm that further enhances our application suite of offerings. Application services is poised for growth margin expansion and further quality improvement.

Now, looking at some of the key operational highlights. We remained focused on improving our margins and cost competitiveness through our productive programs. The automation and costs reduction issues are on-track, while our accounts [starter] teams are helping to improve the early performance of contracts. We are on our way to achieve our 2007 target of an additional 1 billion in productivity improvements. More specifically our efforts to reduce labor costs through workforce optimization are accelerating.

Let's look at slide 7 on Best Shore. We continue to invest and make progress towards our workforce alignment initiatives. At the end of the first quarter we have increased our Best Shore headcount by over 9% versus year in 2006, now with approximately 35,000 resources. We have also opened two new global service centers, one in Cordoba, Argentina and one in Wuhan, China. We strengthened our presence and offerings in both of those key regions and we remain on-track to achieve our target of 45,000 resources in Best Shore locations by year-end 2008.

Quality on slide 8 is a strong testament to the performance of our delivery organization and more importantly our client satisfaction. As we monitor and measure our performance base on incidents that major down time. We improved our Sev 1 metric by over 50% in 2006 have set another target to do this again in 2007 and as you can see incidents continue to tread down 50% during the first three months of the year. Our Zero Outage mentality is taking with new organization, driving quality and resulting in improved results through our client service.

Next slide. So, in summary all in all from growth to operations we continue to make great progress as evidenced by a solid quarter. The sales and pipeline outlooks remained unchanged. Application services is gaining traction and we are on-track to achieve our full-year Best Shore and productivity goals and services deliveries improving through commitment to quality.

So, with that I would like to pass it over to Ron Vargo for more detail regarding our financial performance, Ron?

Ron Vargo

Thanks Ron and good afternoon. As usual I plan on covering our results for the quarter in some detail and providing insight into our second quarter guidance and our full year 2007 guidance.

Slide 11, first let's talk about the results. Revenues $5.2 billion mid point of our $5.1 billion to $5.3 billion, guidance up 3% on a reported basis and down 1% organically. Adjusted earnings per share of $0.31 versus $0.06 in the first quarter of 2006 and versus our guidance of $0.17 to $0.22. GAAP earnings also $0.31 versus $0.05 in the first quarter of '06. Free cash flow a use of $8 million but an improvement over first quarter of 2006 by $30 million and finally TCV of $3.4 billion.

Slide 12. This slide highlights some of the main items that resulted in our first quarter earnings of $0.31 exceeding our guidance of $0.17 to $0.22. So starting at the high-end of the guidance of $0.22; first, overall productivity, contract performance generated about $0.02 of additional earnings during the quarter. Second, there were several pluses and minuses within in the interest in other categories and tax on a net basis about one penny favorability to what we had expected. And third, really the more significant impact came from what I would call timing events between the first quarter and second quarter.

I would characterize those in two primary buckets; first a number of contract, deliverables and milestones that we met ahead of schedule on certain contracts, which resulted in earnings and revenue in the first quarter rather than the second quarter. And some deferral of severance from the first quarter to second quarter as we got off to a bit of a slow start in some of our workforce management during the year. So, the net change was $0.09, but about two-thirds of that I would characterize as related to timing and one-third to performance and interest in other.

Let's go to slide 13, which is the adjusted income statement and I will just talk about a few items that we highlight here. Revenue is $5.224 billion, were up $146 million over the first quarter of 2006. The MphasiS acquisition, of course, result in revenue in the first quarter and we also disposed the Global Field Services business last year in the fourth quarter and those two items essentially wash each other out, and so the increase is primarily due to the foreign currency benefits especially the higher value, the pound and the euro on a year-over-year basis.

Secondly, operating income up $188 million versus 2006 first quarter, I would draw your attention to the contract performance being a primary driver of that improvement, but also the incremental impact of the Verizon contract termination payment that we highlighted in our fourth quarter earnings call and in our Security Analyst Meeting.

There was $100 million recognition of revenue and operating income in the first quarter of 2007, which is part of the $265 million. Without that $100 million, the operating margin would have been 3.2% in 2007, but I would also note that in the first quarter of 2006 in the operating margin of 1.5, that included the contract, which was in place during the first quarter of 2006.

Now I would like to draw your attention to the tax rate. The tax rate of 36.1% in the quarter was 3.3 points lower than last year due to the fact that the R&D tax credit was not passed until the fourth quarter of 2006, but the 36% tax rate was 2% higher than what we had guided to and I will talk about that a bit later as it will impact our full year guidance as well, because we expect that 36% rate to hold. So in summary, I would say solid results and the timing of certain events from the second quarter to the first quarter provided some additional upside in the quarter.

Now let's take a look at free cash flow in the quarter. Free cash flow as I mentioned earlier was a use of $8 million in the quarter as we've said on number of occasions, this is seasonally our worse quarter due to a number of factors including vendor payments, the productivity benefits in the company really taking hold across the year, compensation payments being paid out in the first quarter of the year as well. This quarter we had a particularly weak performance in receivables and I'll talk a bit about that on the next slide.

But, the items I've highlighted here, cash flow from earnings actually $172 million, better then the first quarter of 2006. But most of that was offset by weaker working capital performance, driven by severance payments, vendor payments and an increase in DSO, partially offset by the incremental impact of the Verizon termination payment. A portion of which was recognized in revenue and earnings. That was the $100 million and a portion $125 million, which is on the balance sheet. Net capital expenditures were $250 million, more or less in line with the approximately 5% of revenues that we typically run at.

So in summary, the profit improvement during the quarter and the Verizon payment were offset by other working capital items. We will talk later in my presentation about maintaining the full year outlook. And that assumes that we get back to the targeted working capital numbers and maintain the capital at approximately 5% to 5.5% revenues for the year.

Now, let's go to slide 15. That gives a little more detail behind the changes in working capital, the accounts receivable first, the balance increased by $153 million. On a DSO basis, that was actually much worse because the first quarter was a materially lower revenue quarter than the fourth quarter. The DSO increased from approximately 56 to 64 days from the fourth quarter to the first quarter and we anticipate across the year getting back to DSO in the mid 50s.

Deferred contract costs were pretty much as expected, these resulted primarily from some of our newer contracts craft in the DII for example, account payable and accrued liabilities another significant use of cash $243 million. Severance payments were approximately $80 million in the quarter, a large portion of those in fact the majority of those related to severance that was accrued in the fourth quarter of last year, and represented therefore decline in accrued liabilities.

But in addition, I have mentioned seasonal compensation payments and other vendor payments were significant in the quarter as well. And finally deferred revenue was up $138 million and that is essentially the incremental impact of the Verizon payment. So, we still anticipate managing working capital down across the year to a level of approximately 2% of revenue.

Slide 16, I will spend very little time on the balance sheet movements because most of these were already covered on the working capital slide earlier. I would note that cash and marketable securities down by $192 million is essentially due to the net share repurchases in the quarter, we repurchased $285 million worth of shares in the quarter and that was partially offset by equity that came in from employee stock option exercises and equity comp plans. The debt to total capital remained at approximately 28% for the year and we had a deminimus impact from the adoption of FIN 48 which was a requirement in the first quarter.

Now let's go to Slide 17, which discuses the 2007 second quarter earnings per share guidance, but before I discuss the graphic, let me cover the full year numbers for you. Again, no change to our full year revenue guidance of $22 billion to $22.5 billion, no change to the free cash-flow guidance of $1 billion to $1.1 billion and no change to our TCV guidance of $23 billion plus.

For the full year, we are putting a range on the EPS of 155 to 160 and this reflects an increase in our tax-rate to 36% primarily due to a German statutory rate change that is anticipated to be enacted on July 1 of 2007. It’s actually a decline or a reduction in the German tax-rate from 39% to 31%, but we have, we carry certain deferred tax assets on the books as a result of net operating losses and tax timing differences in Germany and as a result of the reduction in the tax-rate, when that tax change is enacted in Germany, we would be required to write down the assets on our books and that would have an approximate $0.07 impact on our earnings.

A non-cash write down of defer tax assets, but significant enough that it would drive the tax rate to 36% for the year. Now let's talk about the graphic and in the graphic what we have done is walk you from our $0.31 share of earnings in the first quarter to a guidance range of $0.22 to $0.27 in the second quarter or a margin of 5.1 to 3.5. I would point out again that we would identify approximately $0.06 in the earnings in the first quarter as relating to timing differences that we would have expected and did expect in the second quarter, but they came through in the first quarter, the $0.04 related to milestones and the $0.02 of severance.

As we look into the second quarter we expect to see continued productivity momentum and benefits from sequential revenue growth driving increased earnings. However, offsetting those would be the contract delivered both in milestones that occurred in the first quarter and increase in severance in the quarter from low level in the first quarter and finally the Verizon impact where we recognized the $100 million or approximately $0.12 a share in the first quarter that we will not recognize in the second quarter because of the lumpiness in the way that we will recognize that $225 million, $100 million in the first quarter and $125 million in the third quarter. So guidance for the quarter is $0.22 to $0.27 per share on revenue of $5.3 billion to $5.5 billion.

With that I'll turn it back to Dave.

Dave Kost

Thank you, Ron. Operator, I'd like to open the call for questions and I would ask that you limit your questions to one per person.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from George Price with Stifel Nicolaus.

George Price - Stifel Nicolaus

Hi, thanks very much for taking my questions. First of all, I wondered if you could maybe give us an update, Ron, on looking out into '08 in terms of the Verizon impact, 100 basis points of operating margin, and where you stand now? Are you guys still comfortable that you can still that hold and then some for your prior expectations?

Ron Vargo

Thanks, George. As you know we've not provided any specific guidance for 2008 and won't provide any specific guidance during this call. We see looking at into '08, a continuation of the benefits from productivity that will continue to occur throughout 2007 as well as some benefits from the ramp up of major contracts that we've signed in late 2006 and 2007 combined with reduction in our overall investments in SG&A and some impact although probably more mix towards more applications in the business. And we believe that those benefits can offset the gap that would be left by the Verizon shortfall in 2008, but we're not providing any specific guidance today around that matter.

George Price - Stifel Nicolaus

Okay and then just if I could just around the tax-rate, when was that identified? Should we expect the 36% for each quarter of the year? And then is there a deferred cash flow impact from that in 2008 or at any other point?

Ron Vargo

Yeah. I think that full year tax-rate will be 36%. The first quarter tax-rate was 36%. I would expect a bit of lumpiness in the second, third and fourth quarters, where the third quarter will probably be higher, second quarter a little lower and on average for the year at 36%. I would think about that as a non-cash event. In Germany the deferred tax assets have an unlimited life and so, I wouldn't think about that as kind of hitting our cash flow in '08 through '09. I would just think about that as a non-cash event for the near term years.

George Price - Stifel Nicolaus

And I am sorry and when was that identified? When did this take place?

Ron Vargo

It was announced by the German government during the first quarter of the year, but it still requires the German government to enact the change and that's anticipated to happen on July 1st. And so we have not included anything in the first quarter for what we believe will be a third quarter event when the law is enacted.

George Price - Stifel Nicolaus

Okay. Thank you.

Operator

Our next question comes from Bryan Keane with Prudential.

Bryan Keane - Prudential

Hi, good afternoon. In order to hit your bookings target of $23 billion plus with the three or with the first quarter bookings numbers looks like you will need to do at least $6.5 billion or higher a quarter. I guess that will be higher than the typical run rate of the company, do you guys expect it to be evenly spread or booking expected to be back half loaded?

Ron Vargo

Ron, do you want to take that?

Ron Rittenmeyer

This is Ron Rittenmeyer. Number one I don’t expect it to be even, deals are never even. We will continue, we are sticking with a 23, we are comfortable looking at our pipeline and what we have got the pipeline has improved, continues to improve, so we signed, we won probably more than 890 deals in the quarter that makes this up, so, the first quarter. So, we have quite a few deals on a table, many in progress, it's hard to sit here and tell you that they are going to be evenly spread or back ended, deals tend to slide towards the fourth quarter just because the way negotiations work. But all I can say at this point that $23 billion is a number that we have signed up for. I don’t know reason at this stage to feel that that would be at risk.

Bryan Keane - Prudential

But the pipeline is little less megadeals, I think you said--

Mike Jordan

Yes, that's true. We said that even in February, this year we do have some megadeals, your current definitions of megadeals, but megadeals over $1 billion. There is a few of those out there that we have and we are engaged in and then there is a lot of what I would consider to be good size deals, we signed seven over $100 millions in this last quarter. So, when I look at the overall mix uncomfortable, but again to sit here and say to be even would be not a correct statement and it's just the way of the market.

Bryan Keane - Prudential

Okay, and then in order to hit your free cash-flow guidance Ron Vargo, you said you'll need to manage the working capital down to I think 2%, what are some of the key assumptions you'll need to hit in order to hit that cash-flow guidance?

Ron Vargo

I'd say it's primarily Bryan, around work in the days sales outstanding receivables to a mid 50's kind of number from 64 days in the first quarter, that's a single biggest item.

Bryan Keane - Prudential

It is pretty comfortable in collecting, get that number down there.

Ron Vargo

Yes, it’s going to be challenge, but we are all focused on it.

Bryan Keane - Prudential

Okay, and then just a last question I had is, there has been a lot buzz about companies in the IT services sector going private, is that an option that EDS would explore or should we not expect that. I guess the worry is that if the ownership structure is up in the air then many clients might hesitate doing business with EDS, so I was just hoping to clear that up.

Mike Jordan

This is Mike Jordan, yes we've heard those rumors too. I don't know, obviously we are not going to comment on it. But I would say one thing, I think the marketplace environment has changed so much in the last three to four-year's and I don't think, yes there is a lot of speculation about people in our sector and I personally don't think it’s a big deal one way or the other.

Bryan Keane - Prudential

So you don't think it doesn't impact U.S.

Mike Jordan

Even though, we don't think it's impacting will impact us at all.

Bryan Keane - Prudential

Okay, thanks a lot.

Operator

Our next question comes from Rod Bourgeois with Bernstein.

Rod Bourgeois - Bernstein

Hi, guys, I just wanted to talk to you about the revenue picture a little bit here, the revenues were little bit light versus the expectation on the street. And I just wonder to, you talked about whether you guys were a little disappointed with the revenues. And if they would had to do with some delays in signings that you will pick as the year progresses or whether that was attributable to something else?

Ron Vargo

Yeah Rod, Ron Vargo. There were a couple of unique items that affected the quarter-to-quarter comparison. One is if you remember in the first quarter of 2006 we signed the navy modification and extension agreement and that actually resulted in a one-time revenue adjustment that we booked in the first quarter of 2006 of $116 million that was of significant difference between first quarter of '06 and first quarter of '07.

There were also a few other contracts in the UK, that had revenue declines on a year-over-year basis one resulting from a contract termination in 2006, but on a whole outside of those events because we also had some favorable comparisons. We still feel pretty good about revenues. We came in at the middle of our guidance and we are reinforcing the guidance for the full year.

Rod Bourgeois - Bernstein

Alright. Ron, while I got you there. On the free cash flow side the mix shift towards Apps, I am guessing that will help you on the capital spending side. And then you have got most of it goes down in order to hit the guidance range. Is there anything in the pipeline, I know you have got a couple of megadeals there. Is there anything in the pipeline that might create some risk so that CapEx would need to go up to a level that might put the free cash flow guidance range at risk or do you have a discipline in place to make sure that the free cash flow guidance can be achieved sort of regardless of what happened in terms of the deals you win in your pipeline.

Mike Jordan

Ron, this is Mike. We have pretty good line of site to the deals that would impact us this year on our CapEx and we think that's all taken care of our (inaudible).

Rod Bourgeois - Bernstein

Okay. Great. And Mike, can you just comment on where you think you are with the overall turnaround progress? You guys [App 2] at the Analyst and in my mind a lot of that has to do with shifting of business mix, which you're making progress on, but how do you feel like you're progressing against that [App 2] strategy?

Mike Jordan

Well, we've identified the areas in addition to driving our whole applications business up stack and which will be aided in a better by our reorganization to emphasize our industry strategic leadership more heavily than we have in the past and then there are other areas like healthcare and we were actively involved in looking at add-on acquisition, so we've got a healthy pipeline of those things and we're not going to chase foolish runs, but we understand what is significant in going forward.

Rod Bourgeois - Bernstein

Thanks, guys.

Operator

Our next question comes from Tien-Tsin Huang of J.P. Morgan.

Tien-Tsin Huang - J.P. Morgan

Hi, thanks. Ron, something maybe you elaborate on the softer market conditions comment in the press release, can you be a little bit more specific where specifically are you seeing the softness?

Ron Rittenmeyer

This is Ron Rittenmeyer. From a market standpoint, I guess we were really referring to was the size of the deals are not as large as they were before. We talked about applications being much stronger. ITO was not as robust given the prior year. But of course we are trying to overlap some pretty big contracts with GM and NMCI. I mean if you go back and look at just those, if you take those out of course we were up over prior year.

So from a market standpoint, I think its size has a lot to do with it. We did sign seven over a hundred but still, we don’t' have the number of megadeals we had previously. So, it requires a lot more deals, a lot more activity to get to the numbers that we're talking about. We're pretty comfortable that's doable but that would be the only place that I would be concerned about. Again when you compare signings, if we take NMCI and GM out, we were actually up 35% over that base from 1Q06.

So, on one respect, I think it's a positive, but when you have to look at it compared to year-over-year it is less and we have to be realistic about that. But we had a good signing in renewals. What's interesting to me is almost 50% of our stuff was in add-on's, which is a good sign, 22% up on new logos. So, on one side that's positive but on a year-over-year basis, we still had to overcome some pretty big signings.

Tien-Tsin Huang - J.P. Morgan

Okay, well it sounds like Apps is on-track. How about the BPO business? How is that tracking?

Ron Rittenmeyer

BPO, again I think we do pretty well in the healthcare side. We feel pretty good about that. But again, it's all part of our M&A strategy is a piece of this that we’re looking to build out more on. But from a healthcare standpoint, we're doing fine and we have actually several deals in other areas on the BPO side that are in process. So, BPO on averages balanced about zero year-over-year and we need to get more growth out of that just from a margin standpoint as well.

Tien-Tsin Huang - J.P. Morgan

If you could just speak about MphasiS how is that tracking?

Ron Rittenmeyer

MphasiS is actually doing very well the comparison of where we were year ago to today obviously is significant, the synergies are playing out pretty well. We have actually done a lot of complimentary things, Vodafone is a great example of that, and we now got about 20,000 professionals, we added about 2200 in India alone this quarter.

So, they clearly are a major part of the portfolio and then but I did mentioned real queue which is a pretty big deals for us. Although, it's only 700 employees, it is a major testing facility there we really expand the portfolio. The overall MphasiS plus our overall India business is very positive and very sound.

Tien-Tsin Huang - J.P. Morgan

Actually for Ron Vargo, I can speak one last one. Did you quantify the milestone related revenue that was put forward into Q1 from Q2?

Ron Vargo

I didn’t but I did mention it was about $0.04 and that's probably in the ballpark of $30 million or so.

Tien-Tsin Huang - J.P. Morgan

In terms of revenue?

Ron Vargo

That's the earnings impact, I didn’t quantify the revenue impact sorry.

Tien-Tsin Huang - J.P. Morgan

Okay, so you can't give us a sense in the revenue?

Ron Vargo

I don’t have it at my fingertips.

Tien-Tsin Huang - J.P. Morgan

Okay. Thank you.

Ron Vargo

Sorry.

Operator

Our next question comes from Julio Quinteros with Goldman Sachs.

Julio Quinteros - Goldman Sachs

Hi guys. Let me just go back real quickly to the comment you just made regarding renewals, new logos can you just walk us through if you were to strip out the noise from General Motors, how would that have performed I guess relative to your expectations, I thought I heard something like a 35% numbers, just wanted to make sure have about those.

Ron Rittenmeyer

Yes, he didn't, its Ron Rittenmeyer, the TCV was up 35% over first quarter '06 when we strip that out.

Julio Quinteros - Goldman Sachs

Okay, and what about the comparisons between renewals and new logos at this point.

Ron Rittenmeyer

I didn't have that, but it's hard to do because again, GM, MCI, did have a big impact on that, but I would say that compared to where we expected it what our expectation was, it was right in line with what we expected, what we planned and what we anticipated. So that would be a better way to answer that I think.

Julio Quinteros - Goldman Sachs

Okay, and then Ron looking at the second quarter and thinking about organic revenue growth, you highlighted a series of different items that included from seeing any organic revenue this quarter, are there similar comparable things that we need to make sure we account for as we think about the organic revenue growth of the model 2Q07 versus 2Q06.

Ron Vargo

No, I don't see any special items that were in 2Q06 that should cause any impact on our second quarter, comparisons.

Julio Quinteros - Goldman Sachs

So no grow over hurdles then.

Ron Vargo

No.

Julio Quinteros - Goldman Sachs

Okay, and then for the full year in terms of organic revenue growth expectations, can you strip out the assumption for currency that you guys are making now?

Ron Vargo

Well, for the full year?

Julio Quinteros - Goldman Sachs

Yes.

Ron Vargo

Well, it kind of varies given the range that we have out there, but I would still say that in the range of 22 to 22.5 if we can come in at the high end of that range, we still see organic growth, been in the 3.5% to 4% area.

Julio Quinteros - Goldman Sachs

3.5% to 4%, so that excludes currency impact.

Ron Vargo

Yeah.

Julio Quinteros - Goldman Sachs

Okay, great. Thank you.

Operator

Next question comes from Adam Frisch with UBS.

Adam Frisch - UBS

Thanks. I just wanted to address the M&A pipeline. One last time, I think it's been asked from a couple different angles, but wanted to get it this way. And Mike the question is for you, I am assuming you were talking there in your comments about being new acquirer, given your comments on the [IBO] stuff, so are you guys still focused on the domain expertise, offshore capacity and Apps or are you also looking at potentially expanding your core business in whether the U.S. or EMEA or elsewhere.

Mike Jordan

I think we have, Adam we have a kind of bifurcated strategy, one is clearly to enhance our applications and practice capabilities in certain industries and technology. So, we are continuing to look at specialized, other specialized acquisitions that build those capabilities some industry basis, some just offer. At the same time we are looking at building our business and manage services integrated processing businesses to expand around our healthcare and other high priority and financial processing as well other high priority markets like that. So, we are really doing both and have a very active program in each area.

Adam Frisch - UBS

When can we expect something to kind of finally come to [fully] back?

Mike Jordan

When you want some an announcement, but we have to expect the second half of the year or second quarter, third quarter and such things some action.

Adam Frisch - UBS

Okay, second or third quarter. On the DSO side for Ron Vargo, is it relatively early of the year-end collection efforts can be intensified pretty quickly? So, I was wondering because you did seem to be backing away a little bit. If there was anything with these receivables that you currently have outstanding that maybe out of your control or non-collectable, or they more focused in on the federal government side where it's a little harder to tell?

Ron Vargo

Adam, I'd say we underachieved across all regions, so it includes commercial and government customers. I think we probably overachieved a little bit in the fourth quarter of last year and we actually had higher free cash flow in the fourth quarter than we had anticipated, but we have efforts underway to get back on-track across the board and get the number back down to the mid 50 from a DSO standpoint by the end of the year.

Adam Frisch - UBS

By the end of the year, okay. And then last one on Verizon. Just to clarify here I didn't get it in the commentary. It was $100 million incremental operating margin quarter and also free cash flow, how could it be the same if there tax is involved? Did I get it wrong there?

Ron Vargo

Well, no it was $100 million incremental to operating income, not incremental year-over-year, but the $100 million payment, all went to operating income. $100 million of the $225 million payment went to operating income. The other $125 million I mentioned is on the balance sheet as deferred revenue, so the cash in was $225 million, $100 million recognized in operating income, $125 million recognized is deferred revenue.

Adam Frisch - UBS

Okay. And the cash flow impact was wide in the quarter?

Ron Vargo

Of Verizon's payment?

Adam Frisch - UBS

Yes.

Ron Vargo

I'd say $225 million.

Adam Frisch - UBS

Okay. So then the use of cash went through okay, so year-over-year, it was a lot weaker but you explain the differential between first quarter '07 and first quarter '06.

Ron Vargo

Yeah

Adam Frisch - UBS

In the working capitals.

Ron Vargo

That's right.

Adam Frisch - UBS

Okay, thanks.

Ron Vargo

Yeah.

Operator

Okay, our next question comes from Joe Vafi with Jefferies & Company.

Joe Vafi - Jefferies & Company

Hi gentlemen, good afternoon. I was wondering we could circle back to the applications business for a bit. Obviously, nice performance there up 9%, obviously also prior piece of that was MphasiS. I wonder if you could talk a little bit about the Apps business outside of MphasiS and performance in the quarter?

Mike Jordan

I am not exactly sure which way you're going with that. In terms of Apps overall, we talked about the total number. MphasiS is part of that number. We don't necessarily break it out as a separate number. Our Apps business, 34% of our signings was very positive. Other than that, what I would say is that we signed, with the Vodafone signings last year that propelled it and then we've had several signings that continued to build at.

So, we're pretty confident that this is an area that we're beginning to show much more growth than we've had before. And revenue NTCV expansion in it. And the reason I talked about the acquisitions was again to talk about not only strengthening some practice areas like SAP but also to add other capabilities, which was protesting piece, which is pretty significant when you can centralize your testing in one place.

So, we're collapsing, what was the EDS testing and probably even some aspect of the MphasiS testing all into this RelQ plan where we'll have one focus testing area. And then grab the other areas up to be much more from a development standpoint. So, all I can comment on is that the growth based on the numbers we are showing is pretty positive in what we said we were going to do in this area we are beginning to deliver against.

Joe Vafi - Jefferies & Company

Okay, and then just following up on that since it was such a large piece of the signings and I assume given the nature of application to work that type of business should convert to revenue at faster clubbed than in ITO contract?

Mike Jordan

Well, it’s a mix, some of the revenue is for longer term projects, some for shorter terms. So by definition shorter term things will convert to revenue faster, but some of the other things will stretch out over several quarters. So, I mean it just depends on each of the deals when you look at some of the larger deals we are singing are for multiple periods of time. Three-year deal versus seven-year ITO deals, so the answer generically will be yes, but it doesn’t mean it will show up next quarter.

Joe Vafi - Jefferies & Company

Okay. And then just one final question for Ron Vargo, is on if you could break out how much severance was in earnings and EPS for the quarter end, how do we see that trending over the next few quarters. I know there was some timing issues between Q1 and Q2 there? Thanks.

Ron Vargo

Yeah, severance was in the area of $25 million in the first quarter and we expect it to be materially higher in the second quarter and we'll see how it plays out from there.

Operator

Our next question comes from David Grossman with Thomas Wiesel Partners.

David Grossman - Thomas Wiesel Partners

Hi, thanks. Just a follow-up a little bit on the last question Ron, on just specifically could you give us some color on what is a maturities of these contract wins are coming from new or existing customers and is there any particular segment that you are actually taking share from some of the other vendors?

Ron Vargo

What I said about the first quarter in general was that we had about 25% renewals, roughly 50% add-ons and then new logos made up the rest for the most parts, so new logos or new customers renewals and add-ons or renewals of existing business and ad-ons to existing business those are usually the best business for you, especially add-ons, so they help sort of margin expansion. The new logos clearly, we are competing face-to-face with our same people as we always do and we are winning in terms of our win rates, our win rates are pretty consistent with the past.

We don't disclose win rates, but I would say that they are relatively consistent overall and when I look at 1Q07 over 1Q06 win rates are pretty much at the same balance, especially if I strip out GM, and MCI, we sometimes tends to distort those numbers win rates continue to be pretty consistent and we are pretty pleased with our overall win rates. So I think we are right where we want to be for the quarter and of course we always want to be higher.

David Grossman - Thomas Wiesel Partners

The question actually was specifically related to the Apps business is that hold to those comments hold true?

Ron Vargo

Yes, it obviously it holds true across the broad for our overall business, we don't break it out by service line in terms of conversation.

David Grossman - Thomas Wiesel Partners

Right, to what extent do you think the MphasiS acquisition and your ramping of resources off-shore is positively impacting your Apps business.

Ron Vargo

I think it’s very positive. It obviously has a big impact having MphasiS was a significant strategic move for us and has prove to be very valuable, so I think having 20,000 resources in India, for the size of our business is excellent and we are going to continue to grow that area. But I think the important notion is that we'll have 45,000 is our target globally and if you step back and think about that we're not totally relying in one area. So, from a Best Shore standpoint we are pretty diverse and that has proven to be a very positive and helpful thing for us.

David Grossman - Thomas Wiesel Partners

And just one question for Ron, getting back to the receivables question. What exactly is the issue with the receivables and particularly given that you think it's going to take sometime for this to play out over the course of the year to get yourself back down to more normal level. Obviously stripping out seasonality, really what is at stake here and what is the underlying cause of the increase in receivables across the board?

Ron Vargo

Yeah, I would say there is probably a couple of factors and one is seasonality that just affects the DSO because of the low revenues in the first quarter, vis-à-vis, say third and fourth quarter of last year. And I think we were as I mentioned earlier more aggressive in collecting our invoices in the fourth quarter of last year and less aggressive in the first quarter of this year. On top of that I think we let some of our, what we call late payments or past dues grow beyond where they should be and so its not something that we don’t believe we can fix, but its going to take effort at the contract level to get out and work it. Some of it is systematic and some of it is just to make sure you get paid on time for the services you deliver.

Ron Rittenmeyer

It's Ron Rittenmeyer, operationally first quarter is a lot going on, pipeline building, other activities. I think you come off the fourth quarter just human nature you really got to keep the focus on it. We probably get as much focus as we should have, so its clearly an area that we are attune to in from a field standpoint we will be very attune to in the second quarter and third quarter. To Ron's point, simply getting paid, what you own making sure that it happen.

David Grossman - Thomas Wiesel Partners

Just from a benefit I may, do their clients looking at working capital and receivables as a means of kind of a not necessarily negotiating points, but extracting some kind of marginal benefit pricing --

Ron Rittenmeyer

I don't think it will be fair to make that generalization. I'm sure that people always want to pay their bills on time. Sometimes they just don't do it, so I don't want to. I think that would be an indecisive statement that I'm not quite sure it’s fair to the clients and in generalization.

David Grossman - Thomas Wiesel Partners

Okay. Thank you.

Operator

Our next question comes from Gregory Smith with Merrill Lynch.

Gregory Smith - Merrill Lynch

Yeah, hi. I'm just a little confused on the German tax issue. Ron Vargo the $0.07 non-cash write down you were talking about, is that reflected in the 2Q guidance or is that $0.07 somehow spread out throughout the remainder of the year?

Ron Vargo

That is expected to occur in the third quarter of 2007, so it is not reflected in our 2Q guidance.

Gregory Smith - Merrill Lynch

Okay, but it is reflected in the $1.55 to $1.60 range?

Ron Vargo

Absolutely right.

Gregory Smith - Merrill Lynch

Okay. Great. That helps. And then just wondering if you guys maybe looked at Covance. It's been what you thought of that deal with CSC?

Ron Vargo

We obviously look at in a periodic basis all the sectors related to our business. It's a decent company. Clearly it was a major hit, I think benefit to CSC because it didn’t have the India presence that we do.

Gregory Smith - Merrill Lynch

Fair enough. Thank you.

Dave Kost

Operator, we have time for one more question please.

Operator

Our last question comes from Moshe Katri with Cowen & Company.

Moshe Katri - Cowen & Company

Thanks, the last question. Can you tell us what sort of a renewal rate is embedded in your '07 booking projection number? Thanks.

Mike Jordan

We don't have that number that we provide, sorry.

Moshe Katri - Cowen & Company

Okay, are you planning to have major renewals for the rest of the year?

Ron Vargo

Yes, we don't have any large significant renewals this year. We always have renewals there just part of the business.

Moshe Katri - Cowen & Company

Understood, thanks.

Ron Vargo

Yeah, but nothing that I would say stands out that we should talk about.

Moshe Katri - Cowen & Company

Okay.

Dave Kost

Okay. With that operator, I'd like to thank everyone for joining us on the call today. I know there were still some of you with questions in the queue, so please feel free to call my office and we'll be glad to talk through those questions with you.

Operator

Thank you. And that concludes this afternoon's EDS first quarter 2007 earnings conference call.

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Source: Electronic Data Systems Q1 2007 Earnings Call Transcript
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