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Electronic Data Systems Corporation (NASDAQ:EDS)

Q4 2007 Earnings Call

February 6, 2008 5:00 pm ET

Executives

Dave Kost - IR

Ron Rittenmeyer – Chairman, President, CEO

Ron Vargo – EVP, CFO

Analysts

Rod Bourgeois - Sanford C. Bernstein

Abi Gami - Banc of America Securities

George Price - Stifel Nicolaus

Adam Frisch - UBS

Jim Kissane - Bear Stearns

Bryan Keane - Credit Suisse

Operator

Good morning, ladies and gentlemen, and welcome to the EDS fourth quarter and full year 2007 earnings call. (Operator Instructions) I will now turn the call over to Mr. Dave Kost, Vice President Investor Relations.

Mr. Kost, you may begin.

Dave Kost - IR

Thank you very much, John. Hello, everybody, and welcome to our fourth quarter and full year 2007 earnings call.

With me today on the call are our Chairman, President and CEO, Ron Rittenmeyer, and CFO Ron Vargo.

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

The information to be 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 Factor 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 this call. Among 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 Ron.

Ron Rittenmeyer – Chairman, President, CEO

Thanks, Dave.

I'd like to take you through some of our business highlights, and then I'll turn it over to Ron Vargo to talk about the finances.

On Page 3 of our slides for the fourth quarter summary results, EPS of $0.55, which is 17% on a year-over-year basis; revenue of $5.8 billion, 2% up. Organic was down 3% and Ron will talk a little bit about that, but it is in line with our overall guidance and it really - free cash flow, et cetera, all came in appropriately.

The next item of free cash flow at $563, 44% over a year ago, and we did hit the 55-day DSO target that we said we would.

Contract value came in at $6.1 billion. That's the second half turned out actually to be the strongest sales performance period, the best second half really since 2001. We did have a slow start to the year as everybody knows. We had a very strong finish in '06, and we came out a little bit slower because of that. But we ended up, again, very, very solidly.

Overall, we had seven contracts in that quarter with TCV over $100 million, and we had very strong bookings in both Healthcare and transportation, which we feel good about.

The next slide, Page 4, year results, EPS of $1.56, which is 58% on a year-over-year basis. Revenue, about $22.1 billion, up 4%. Organic came in flat, somewhat helped by foreign exchange.

Overall, free cash flow of $892, which was slightly higher than 2006, but the quality of the free cash flow was better and Ron will talk somewhat about that as well.

From a bookings standpoint, we came in at $19.5 billion, and I know that'll be compared to the $26.5 in 2006, but I do think we have to consider that those two very large mega-deals, both GM and Navy - which are very, very unusual, given their size - so we tried to keep those a little bit excluded so that we were looking at what I call our base business year-over-year, and so our bookings really up 2% on a year-over-year basis.

The other thing, of course, is we do start out the year using a constant currency foreign exchange rate for the year so this year, because of that, there was somewhat of about - there was probably $1 billion that got lost up in that noise on a comparison year-over-year. But from the 19.5 to the prior year, we were up about 2%, which we think was solid performance given somewhat the late start we had in the year.

Once again, fourth quarter, the fact is we did have some key deals shift. I think what's important is the deals that shifted in the fourth quarter actually were all deals that we have been down-selected to one. So we're not in a competition on these deals that slid. These are deals that we've already been chosen for, we're just in the contracting phases and quite candidly, it's just that December's not a month where you can always get everything brought to the table and fully contracted. So we believe that also will be a good start to this year.

Fourth quarter signings on the next page, the Americas region, particularly the U.S. and Latin America, they had a very strong booking quarter. They signed about 69% of the total TCV.

In Q4 when you look at our service line split, it was weighted a little higher, with ITO deals at 58% of the bookings.

Application continues to show really good performance, and that's in line with the strategy we've talked about at about 30% of our signings.

BPO business posted 12% of the TCV, as you can see on the slide. When we look at it from a vertical industry standpoint, we had our strongest fourth quarter performance from Healthcare and the Financial Services team.

Again, we signed seven contracts with TCV greater than $100 million during the quarter. And just to highlight a few which you probably have already about is the Bristol-Myers Squibb signing was a very good signing, new logo, of course. A seven-year IT services extension with Continental Airlines was important, as well as a contract extension with Indiana Medicare, which really leveraged our leading-edge interChange Health System.

So all in all, quarterly signings were strong. We're happy with the momentum in the market, and we feel good about it.

So let's look at the next page, Slide 6, which is our update on sales effectiveness. The full year, we had 28 wins over $100 million versus 26 in 2006. Again, that's the third year in a row with mega-deal signings in the upper 20s.

Existing client bookings were up 4% year-over-year. That really reflects a turnaround in existing account sales improvement, so we're very, very bullish about that.

Our new logo signings in the Q4 were the second highest in a fourth quarter period in the last five years, and we accomplished this without any deals over $1 billion which, of course, comparing to 2006, where we actually had three of those. So we think it was a very strong, solid year from a sales effectiveness standpoint.

Let's take a second and talk about the pipeline. We added sales and sales support capacity as well as increasing our app sales capacity. We made several improvements in our sales process that's going to help us in our existing client base, and we feel our pipeline remains really robust. It's up 10% versus a year ago, with strength coming from both ITO as well as the broader Applications market that we've been talking about.

Apps, domain practice deals such as SAP and testing, which are typically less than $10 million but good-quality deals are up 21% from a year-over-year basis from a pipeline perspective.

And from an industry standpoint, Energy, Healthcare, Financial Services and Manufacturing really have the strongest year-over-year growth in the pipeline. The good news to us is all regions are showing very healthy pipeline and growth.

Page 7, when I look at Applications, our revenue was up, was $1.7 billion, which is flat versus a year ago. And if you'll recall, a year ago we had some strong end in EMEA on Applications.

The booking and pipeline is very strong, and we are beginning to transition to a greater offshore mix which, you know, obviously does some impact. I think everybody understands that masks your actual growth because of the way you price it from an offshore standpoint.

Application services increased to 31% of total revenue, which is up from 30% last year when we ended, and signing were 30% of the total TCV in the fourth quarter.

For full year '07, app signings were about 32% of TCV. The pipeline truly continues to improve.

And finally margins were down slightly due to the investment in the build out of this business model. Over time we clearly expect margin expansion in Apps to translate into real bottom line improvement. That's why we're doing it.

Our Applications momentum overall, I think, in summary, continues to improve.

Let's turn to the next slide, which is our Best Shore slide. As you can see, the bar graph, we're now up to about 41,000 employees. We have about 27,000 of those in India, which is by far our largest Best Shore location.

We've established an updated goal of achieving 60,000 EDS employees in our Best Shore location over the next two-and-a-half to three years, and given our existing size and scale, our primary focus is now on improved integration of our global delivery as well as our quality improvements.

Turnaround improvements on recent client Service Desk migration to us are really very, very solid proof points, so we feel very good about this.

Turning to the next slide, which is quality - which I know you've heard me speak of frequently - we're making significant strides in this area. Quality improvement continues to be what we believe is one of our most important responsibilities for every employee.

Our Severity 1 incidences continue to decrease significantly, and we continue to hold out zero outages as a mindset that we want to go to. For 2007 compared to 2006, our Severity 1 incidences decreased by over 74%, and this improvement's really been driven by utilizing the global services network, new software tools and process changes. All of these improvements are sustainable and obviously feed a lot into our productivity, and we believe that's a very strong differentiator for us in the market.

So in summary of 2007, I would say it was a good quarter and a good full year. We clearly are not satisfied with the pace of the improvement, and we expect to focus on that pace as we get into 2008. I'm pleased with the overall recent sales booking trends that have developed in the back half of '07. Quality continues to be, I think, a significant differentiator for our business, and our trends continue to show great improvement.

And I also believe that by any measure, we have made a significant progress in the last year and a half with changing our Best Shore labor mix, which really has enhanced not only our competitiveness but our overall productivity. And clearly we still have work to do, and we accept that.

And then finally, I think we have a very strong balance sheet and cash position which really gives us some flexibility. So if I had to say what is our priority going forward, it's focused on margin and free cash flow improvements, and that is the number one project that we are focused on.

Looking ahead in 2008, Ron's going to talk about the guidance, which I would say we have maintained that guidance that we spoke about on November 2 at our third quarter earnings release, and we've maintained that guidance across the board in EPS, operating margin and in revenue and free cash flow. So Ron will talk about that, so no changes to that.

From a growth standpoint, we're going to continue to invest in sales. I expect the pipeline will fuel much more growth. Best Shore, when I look at over Best Shore content, it now exists in almost every deal we're doing, and we will continue to use that as a leverage point.

We believe there is very solid market demand for Applications modernization and industry solution, particularly among our broad client base. So we feel very good about that.

As far as the macro economic risk, I mean, we are clearly very carefully monitoring and evaluating any impact in each of the markets that we service, and we believe that at this point we still see market strength in what we do. We are going to scale back if needed in areas that show up, but we are just as pure - just from a pure, solid, good business sense, really focused on our discretionary spending as we look at our own margins and free cash flow.

But at this point we believe that from a macroeconomic standpoint, we haven't seen anything that puts us in a serious state of concern. But it's certainly something that we are monitoring and very aware of.

On an operational standpoint, we are going to continue to drive earlier execution on workforce management. I expect a heavier impact in the first half. I think it's important to us to continue to improve our overall margins and cash flow efforts.

We're going to be aggressive with process improvements through best practices. You'll hear more about that at the security analysts meeting in a week or so.

And I think that 2008 is clearly a year for us where we make a difference in our Applications business. We are running it now as a profit center versus just as a delivery organization and measuring it with accountabilities accordingly. We are using our practices and industry structure to help feed this and develop it and taking accountability down to the levels that are important for execution.

So execution's what we do. It's an important part of our 2008 and 2009 margin expansion. I didn't put M&A on here, but clearly M&A continues to be something we're going to look at for enhancements, but it's not going to be just the single thing that we're doing in 2008 and 2009 to improve our business. If anything, it'll be there as an enhancement.

So that is my - that completes my part, and I will now hand it over to Ron Vargo to talk about the financial section.

Ron?

Ron Vargo – EVP, CFO

Hey, great, Ron. Thanks, and good afternoon to everybody.

I'll be covering results for the quarter and be discussing a bit about our 2008 guidance, so let's go to Slide 13, summaries of results for the fourth quarter.

Total revenues were $5.8 billion, up 2% as reported and down 3% on an organic basis.

Adjusted earnings per share of $0.55, up $0.17 versus the fourth quarter of 2006.

And reported earnings of $0.36 were impacted by the early retirement offer that we charged in the fourth quarter, and I'll talk a bit about that later. So down 10% versus the fourth quarter when including all items between GAAP and adjusted.

Free cash flow, as Ron said, was $563 million, an improvement of $171 versus last year.

And finally quarterly bookings of $6.1 billion. And again, it was a very strong quarter. And seasonally, as you know, the fourth quarter is typically an extremely strong quarter for EDS, and it was again in 2007.

Slide number 15 - 14, I'm sorry, is the earnings per share reconciliation between GAAP and adjusted earnings. GAAP earnings were $0.36 and adjusted earnings were $0.55. The major item, of course, impacting GAAP was the $0.18 impact from our early retirement offer, which we completed in the fourth quarter and which we discussed in some detail with you in our third quarter call, so fully expected to see a charge in the 17% to 18% area.

We also had another $0.01 impact primarily related to a write-down related to inprocess R&D associated with our acquisition of Saber Holdings in the fourth quarter along with a few other items relating to discontinued ops and prior restructuring.

Slide 15, the fourth quarter adjusted income statement, and this slide contains summary level items from our income statement, again adjusted to exclude certain items. And a detailed walk from the GAAP income statement to this adjusted format is included in the appendix.

Key highlights include revenue, up $128 million primarily due to the impact of FX, which was partially offset by a 4Q06 Verizon termination payment and some revenues in the fourth quarter of '06 from our divestiture of GFS - our divested business GFS.

You will recall that it was December 2006 when EDS transitioned services back to Verizon, and at that point we did receive a termination payment related to that transition.

Operating profit showed a 10% improvement as a result of productivity and lower severance levels which were partially offset by the fourth quarter '06 Verizon termination payment as well as contract price reductions and other contract runoff. This lead to an operating margin improvement of 50 basis points over the fourth quarter of '06.

And finally, the net effect of interest and other and taxes was positive. Interest and other improved primarily because of the interest rate impacts on some of our swap debt.

And our tax expense for the quarter was 31.2%, a bit better than we anticipated. And our tax rate for the full year came in at about 33.5% better than anticipated, primarily as a result of adjustments in foreign and state jurisdictions, which more than offset the impact that we've discussed with you in prior calls resulting from the German tax rate change.

Fourth quarter and full year free cash flow, as mentioned, free cash flow for the quarter was a strong $563 million, driven by higher earnings and strong fourth quarter receivable collections, which lowered our DSO to 55 days. This was partially offset by other working capital items.

Total free cash flow for the year came in at $892 million, and key changes from 2006 include cash flow from earnings up $415 million on a year-over-year basis. Working capital actually negative year-over-year by over $300 million, but the receivables collection improvement again came in very strong in the quarter, but it was more than offset on a full-year basis from a number of changes, including client prepayments in 2006 that have impacted deferred revenue in 2007, higher severance accruals in 2006 in which the payments were made in 2007, and higher deferred contract costs associated with some of our larger contracts.

Net capital expenditures came in higher than last year by $103 million, but this was driven primarily by lower asset sales and lease-related proceeds, which in total were down over $200 million. So if you look at kind of core capital expenditures, we actually improved on a year-over-year basis. And so the quality of our free cash flow in '07 was actually better than the quality of the free cash flow in 2006.

Balance sheet, on this slide I'll review briefly selected year-to-date balance sheet movements, and the most notable movements include cash and marketable securities, up $177 million. Key components of this change were the free cash flow of $892 million, offset by net share repurchases during the year and acquisitions during the year, including the fourth quarter Saber acquisition as well as dividends. So we offset substantial share repurchases and acquisitions and still grew our cash by $177 million during the year.

Deferred contract costs, although higher year-over-year on a sequential basis versus the third quarter deferred contract costs were flat, actually down $1 million.

And deferred revenue was down by a little less than $200 million, primarily related to a large U.K. government contract prepayment in 2006.

Shareholders equity increased by $1.8 billion, and there were several factors contributing to that increase, obviously net income but also we had strong performance in our pension assets in both the U.S. and U.K. which contributed to the increase in shareholders equity, and we also benefited from the weak dollar in other comprehensive income from foreign exchange benefits. And all of that was offset by net share repurchases during the year.

So we continue to maintain an extremely strong balance sheet with equity at now $9.7 billion and a debt-to-total-capital ratio at the end of the year at about 26%.

Just a brief word on our new share repurchase program. The Board authorized a $1 billion program in December of 2007. We got off to a modest start to that program, and we purchased a little under $60 million worth of shares - a little under 3 million shares - and expect to continue to repurchase shares during the 18month program from December - starting in December 2007.

Now for just a brief update on that early retirement offer, as you recall this was a U.S.-only program. It was principally a noncash charge because the funding will come from the U.S. pension plan. The financial impact in the fourth quarter was a pretax charge of $154 million relating to the approximate 2,400 individuals who took early retirement, or $0.18 per share on an EPS impact.

Cash flow, again immaterial due to the funded status of our EDS U.S. retirement plan. And as we look out into 2008 and beyond, we expect to backfill approximately 25% of those positions, and that should generate savings of greater than $125 million annually and obviously help offset some of the Verizon impact in 2008.

On a full year 2007 basis, you know, significant year-over-year progress in financial metrics. Revenue is $22.1 billion, up 4% and flat organically. Adjusted earnings of $1.56, up 58%. And again, we walk you from reported to adjusted in the appendix.

Our full year operating margin was 5.8%, and we fell a little short of our own goal of 6% or greater in part due to some contract weakness and in part due to some of the signings that occurred a little bit later in the year rather than earlier. And again, I think as we look out in 2008 we would expect the turnaround in that contract weakness as well as benefits from strong signings in the second half of 2007.

We generated $892 million of free cash flow, and signings were $19.5 billion.

Now let me just turn to 2008. First, just a business context on Slide 23. Top line growth, we expect approximately a 2% year-over-year increase in revenues as growth should more than offset the impact of the Verizon termination and higher runoff and pricing impacts compared to 2007 versus 2006.

This estimate includes revenues from Saber but excludes currency effects, which did have a great impact in 2007 obviously.

And again, we expect TCV to be greater than $20 billion in the year, and we're targeting a 1:1 book-to-bill ration.

Operating margin, we're looking to expand margins before the impact of workforce management charges. And again, we do have the impact from the Verizon termination and runoff as well as workforce charges which we have told you would be in the range of $200 to $250 million.

Our global standardization and best practices will continue to drive productivity as will a continued shift in the global labor mix, and we expect improved contract execution and start-ups to be significant drivers of year-over-year performance.

Free cash flow, we continue to target free cash flow in the area of $900 million for 2008, driven by working capital improvements. We anticipate significant year-over-year improvements that will more than offset lower cash from earnings and a bit higher capital intensity during the year, which we would expect to be in the 5.5% to 6% of revenue range due in part to anticipated growth in our data center facilities.

Now let me share with you just the broad numbers for our full year 2008 guidance, and as Ron Rittenmeyer said there is no change in the guidance that we provided to you at the end of the third quarter.

Revenue, $22.5 billion plus or approximately 2% greater than 2007.

Adjusted earnings of approximately $1.35.

Free cash flow of approximately $900 million.

NTCV of greater than $20 billion.

So just to be clear, the adjusted earnings of $1.35 are net of the impact of workforce management charges.

Our first quarter guidance is $5.1 to $5.3 billion of revenue and approximately $0.05 of earnings, which I'll talk about in a minute. If we would put a range on that, we'd put a range of about $0.03 to $0.07, so let's kind of flip to the first quarter 2008 earnings per share outlook chart.

What I've shown you on this chart is the first quarter of 2007 versus the guidance for 2008. First quarter of 2007 we actually generated $0.31 of profit, but we had $0.13 of the $0.31 related to the recognition of $100 million of the total of $225 of Verizon payment which occurred in the first quarter. And we also, as we discussed on our first quarter call with you last year, saw an acceleration of $0.06 of earnings in the quarter which was unanticipated due to timing of events impacting '07 which we thought would impact - first quarter of '07 which we thought would impact the second quarter of '07.

So net of those items, earnings would have come in closer to $0.12 a share. We also expect to spend $0.08 in the first quarter of 2008 on workforce management charges and incur slightly higher interest and other costs as a result of lower interest rates and some benefits that we saw on our swaps in the first quarter of 2007.

And while we will benefit from year-over-year improvement in productivity and from some of the ERO benefit in the first quarter, this will not be enough to impact the earnings outside of the range of $0.03 to $0.07 a share.

So for the balance of 2008, obviously we continue to expect sequential improvement from contract performance, savings from our early retirement offer, operational productivity, and the net effect of new contract growth in revenues and profitability.

So let me turn it back to Ron Rittenmeyer for a wrap up.

Ron Rittenmeyer - Chairman, President, CEO

Thanks, Ron.

Just a couple points. We believe we had a good year in 2007. Some pretty solid improvements overall, both in the quality of what we did and what we reported.

But clearly, we realize it's not enough, and as I said earlier, we are going to be focused on - from a margin and free cash flow standpoint. Not only focused in terms of how we look at operating but it's also how we do deals. Our business model is improving, to capitalize on that and how we hold people and how we're going to measure people.

The economic slowdown that everybody is concerned about and the question about the macroeconomic issue that I mentioned, we do believe it is important and it is something we're watching, but we also feel we're in a pretty good position. 48% of our business is outside the U.S., 30% of our business is with the government, primarily in the U.S. and the U.K., and a high percentage of our revenue is under long-term contract, which also runs very mission-critical businesses and systems for these clients that can't just be walked away from.

And we believe what we provide is a solution that creates a lot of value and opportunity for clients that allows them other ways to improve their business. So again, I think we feel relatively comfortable that we have a very good model in these times.

Investment in our business has been needed in the last few years. We're making those investments. We talked about the Applications as an example of that throughout '07, and we're going to continue that in '08 and we think they will really drive some serious payback.

In Q4, we completed the acquisition of Saber Solutions, which is an Applications company that has real leverage platforms for state and local agencies on a global basis. We're excited about the business. It's off to a great start, and we think that's going to be a major add to our overall business portfolio.

And we started the share buyback which Ron mentioned, and we will continue to focus on that and move forward.

And we'll provide a lot more color obviously when we meet on the - I think it's February 19th, correct, David?

Dave Kost - IR

Right.

Ron Rittenmeyer - Chairman, President, CEO

The security analysts meeting, where we'll get into more detail by each group.

So with that, I'm going to turn it over to Dave, and I guess we'll take questions.

Dave Kost - IR

Okay. John, with that I'd like to open up the call for questions, and I would like to ask you to limit your questions and be mindful of all the others in the queue.

John?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Rod Bourgeois from Bernstein. Please go ahead.

Rod Bourgeois - Sanford C. Bernstein

Hey, guys. I just wanted to first clarify the 2008 EPS guidance of $1.35.

If I'm reading this correctly, that is exactly the guidance that you gave three months ago when you gave adjusted EPS guidance as $1.35.

When I compare that number to consensus of $1.65, it appears the consensus number excludes a $0.30 workforce management charge, and so I guess what I'm trying to make sure I understand, is your $1.35 EPS guidance consistent with an EPS number of $1.65 excluding the workforce management charge of $0.30?

Ron Vargo - EVP, CFO

Yeah, Rod, it's Ron Vargo. You got it right. I mean, what we're saying is we are maintaining the same guidance that we provided in November, which is $1.35 a share in 2008, and that $1.35 is net of what we said in November, approximately $0.30 of workforce management charges.

So we eat those, if you will. When we report our results, we report our results net of those workforce management charges. In the call last November we actually did say that we would expect about $0.30 of workforce management charges, so we kind of let you decide how you want to treat those.

I don't think the first call ought to be showing a number, you know, before the effect of those workforce management charges. We don't try to adjust them out, very frankly.

Ron Rittenmeyer - Chairman, President, CEO

And we also, Rod - this is Ron Rittenmeyer - we also want to focus on getting those earlier in the year, because the earlier we deal with this, the better for us going forward.

So when we talked about it in November, I thought, you know, I thought we were very clear about yes, we were going to make this investment. We spent a lot of time, I think, dealing with the issue around, you know, transition year and what does that mean and where are you going. So I'm not quite sure how this the two numbers are sitting out there, but that's where we were.

Rod Bourgeois - Sanford C. Bernstein

Okay, great. And another clarification for Ron Vargo.

Your 2008 free cash flow guidance of $900 million, that includes the negative effect of $200 to $250 million of workforce management charges?

Ron Vargo - EVP, CFO

Yes, it does. It's all in.

Rod Bourgeois - Sanford C. Bernstein

Okay. And what were the workforce management cash charges in 2007?

Ron Vargo - EVP, CFO

I don't think we disclosed that, but we certainly paid significant workforce management costs in the first quarter relating to accruals that we had from the fourth quarter of '06. So on a net basis, probably slightly - maybe 15%, 20% lower.

Ron Rittenmeyer - Chairman, President, CEO

In '07.

Ron Vargo - EVP, CFO

In '07 than what we're anticipating in '08.

Rod Bourgeois - Sanford C. Bernstein

All right.

Ron Rittenmeyer - Chairman, President, CEO

Yeah, it's definitely higher in '08.

Rod Bourgeois - Sanford C. Bernstein

All right. So the workforce charges are going up in '08?

Ron Rittenmeyer - Chairman, President, CEO

That's correct.

Rod Bourgeois - Sanford C. Bernstein

And then I'm assuming - are you keeping your target of about $1.1 billion in free cash flow for '09?

Ron Rittenmeyer - Chairman, President, CEO

Yes.

Rod Bourgeois - Sanford C. Bernstein

And if so, is that because you essentially get rid of a couple hundred million dollars in workforce management charges?

Ron Rittenmeyer - Chairman, President, CEO

Well, I hope - this is Ron Rittenmeyer - I think it's for a lot of reasons. That's one of them, okay? But as we've said, you know, it becomes fungible, right? Some of it is workforce management. Some of it is just as you do that you change processes, pick up other efficiencies, so our line of sight is built around a lot of things, and I don't want to just tie it to one thing, Rod.

Rod Bourgeois - Sanford C. Bernstein

Okay. And then, Ron Rittenmeyer, on the margin side, it looks like your margins were probably below your plan in Q4, and so how much of that is timing because of push-outs on contracts versus an execution issue or something related to pricing, and what does that mean for your margin trajectory for '08? Does the pushout in Q4 help '08, or are you behind where you wanted to be as you entered 2008 on the margin front?

Ron Rittenmeyer - Chairman, President, CEO

Well, you know, let's be frank. I think that some of it - it's kind of all of the above, but let me talk about what I mean by that.

Clearly, Rod, I never shy from these things. I mean, there is some contract execution issues, okay? We had a lot of start-ups last year, we had a lot of contracts come up last year. Some of that's that heavy signing in '06. So I think there were some opportunities where we could have done better, and I don't want to hide from that.

But I believe we've got that well - there is no - well, there was nothing that I would say was a burning platform. There were just fundamental issues that we could have done better than what we did, and so there is some of that as performance that'll carry - that carried in '07 that will get much better in '08. So that's part of it.

You talked a little bit about, you know, does that mean the revenue - from a revenue standpoint, that's also part of it, which we should pick up now based on the pipeline and where we see us going.

So when I - I guess when I think about all of that together, I believe that, you know, there's clearly some execution opportunity. Some of it, you know, some of it comes out in the investments that we made in, you know, in our business around SAP and Applications. I would expect that to start coming back in late '08, early '09.

And, you know, so I think you hit on, you know, when you asked the question, you kind of covered all the areas, so I'd have to say that all of those areas are probably - probably play somewhat of a role, but I'm very much - I think very much from a - focus has got to be execution, number one. You know, getting a return on our investments, making sure our business plans on our investments that we're making are very, very tight and very buttoned up, which is an area that we've really put a lot of focus on as we've come into the end of the year going into next year.

So I don't know if that answered what you were asking, but -

Rod Bourgeois - Sanford C. Bernstein

No, that helps. I'll take the rest offline. Thanks.

Ron Rittenmeyer - Chairman, President, CEO

Okay. Thank you, Rod.

Operator

Our next question comes from Abi Gami from Banc of America. Please go ahead.

Abi Gami - Banc of America Securities

Great, thanks.

How far along are you in running your Apps business as a profit center in terms of infrastructure and process?

Ron Rittenmeyer - Chairman, President, CEO

I would say we've certainly got the framing of it done. We've started to make the transitional pieces that you would need from a leadership, organizational and a reporting standpoint. We've hired several new senior leadership people in the fourth quarter, and we're in the midst of doing some more hiring right now.

So, you know, I don't know if I can put a number on it, Abi, but I would say that we've clearly invested in the tools with SAP. We've added the leadership. We've done some of the organizational things that need to be done to make our business perform at a contract level on a global basis. That's a pretty big change, and most of those things are well underway from a tools standpoint, et cetera.

The other thing we've done is we've really aligned it very heavily by industry so, you know, and tied into the hiring, consulting pieces we already had in the industry.

So I'd say we're certainly past the halfway mark, and I think we're making pretty rapid progress. It's a very big focus.

Abi Gami - Banc of America Securities

Thanks, Ron. Would you say it's fair to say that, you know, ultimately you can benchmark the margins and the growth rates of some of the offshore players who I believe you can clearly say are some of the leaders, at least in maximizing those metrics or is there some other reason why, maybe, those metrics are not the most applicable to look at?

Ron Rittenmeyer - Chairman, President, CEO

Well, I think the answer is yes to both.

I mean, you do want to benchmark to the offshore players. They're real players, all right? I mean, you'd be silly to ignore them, and I think we'd be less than thoughtful if we sat here and tried to justify why we wouldn’t do that. So we will do that.

But I do think some degree, there is an apples and orange mix here. While they're moving - trying to move to this onshore model versus - which for them, they're trying to move somewhat to an offshore model for them. We're trying to move to an offshore model the opposite way.

So you've got to be a little careful in terms of how you look at that, but I think fundamentally there are metrics relative to a percentage of work being done where and how that fits, as well as price point rate cards, you know, those kinds of things - stuff we probably don't disclose, but I think that, for us, on the development side that's very, very applicable.

So your point is correct, but it's in the details of that that I think you have to be smart.

The other side I think that we shouldn't discount is we have still a significant maintenance business, and that isn't easy to benchmark to the offshore players because the maintenance business for us is a very profitable business, a very sound business, and a pretty substantial business. It also gives us access that, you know, is something that we don't want to discount.

So while it may not be the high-end margin growth, it's got a lot of other attributes besides making a good margin. It makes a very good margin, but it's also got other attributes in terms of access and knowledge that you don't typically get.

So you've got to look at both of those when you talk about that.

Abi Gami - Banc of America Securities

Thanks. That's very helpful.

Dave Kost - IR

Next question?

Operator

The next question comes from George Price from Stifel Nicolaus. Please go ahead.

George Price - Stifel Nicolaus

Thanks very much. Just wanted to clarify one of the prior questions. The cash impact from the workforce management action, is that, I mean, from a magnitude perspective those are ultimately all going to be cash but from a timing perspective - that's a question. But from a timing perspective, are they all going to hit in '08, or is anything, you know, as you move through the year, you make an accrual for that, are you going to - is anything going to linger from a payout perspective into '09?

Ron Vargo - EVP, CFO

Yeah. Yeah, George, Ron Vargo.

You know, I would expect us to front-end load a lot of this workforce management cost, which would imply that most of that would be cash payments in 2008 and wouldn't carry over into 2009.

Ron Rittenmeyer - Chairman, President, CEO

It's a little hard, though, George, early on to make that totally definitive because Ron's right; I agree with Ron - but I would just say that some of that also depends on other factors like level and who you're letting, you know, there's just other dynamics that I really don't want to get into.

But I think the majority is correct.

George Price - Stifel Nicolaus

Yeah, like if you're letting someone go, you know, abroad, where you may have to I got you.

Another just clarification. The '08 EPS guidance, what are you assuming in that in terms of share repurchases?

Ron Vargo - EVP, CFO

Yeah. I think you can assume that we would execute on our share repurchase plan kind of rateably across the next, you know, 16 months or so which would, net of any new shares that would creep into the share count from comp programs, would give you about a 530 - 5 3 0 - million average share count for the year.

George Price - Stifel Nicolaus

For 2008?

Ron Vargo - EVP, CFO

Yeah, 530.

George Price - Stifel Nicolaus

And then last question, just doing a back of the envelope calculation - maybe I need to go over this with you a little bit more offline - but it seems like the ERO, given the 25% backfill, you know, and some other basic assumptions, it seems like it should give you more than - could give you more than sort of the 55 bps of operating margin that's implied.

What's your feeling on that? Is the $125 million just to clarify, is that the annualized benefit or the benefit that you'll see in '08?

Ron Vargo - EVP, CFO

Yeah, well, you know, I think, George, you're right, first, that, you know, that should generate a higher annualized number.

And, you know, I think there's a little conservatism built into that number for '08 because we do have some people still on who have stayed on on a contractor basis for a few months into 2008, and they will be leaving, you know, in early 2008 before we get that kind of full-year impact.

Ron Rittenmeyer - Chairman, President, CEO

Yeah, that's true. The thing that - let's just enter a little practical side of an ERO. I mean, we have looked at that from a full - but people do have to stay because, first of all, we don't know who they are until we pull the plug, the day that they submit their names and we're done, theoretically, they're either done immediately or pretty quickly thereafter.

And some of those skills, obviously, some of the jobs they're doing you've got to bridge a little bit because even if you hand it over to a lower-paid individual or you decide that you're going to change the process, it's sort of hard to do that in an ERO until you know exactly who stood up and took you know, the rules are such that we can't just pick who goes. They've got to they self-select.

And that's not really something publicly we deal with until the last minute because most people wait until the very last week to finally submit their name. A lot of people go out and investigate it, but you don't know exactly who's going to take it.

So some of this is a timing question, I think is where Ron's going, and we're trying to be realistic about it.

George Price - Stifel Nicolaus

And just to clarify, though, the $125 million, is that the anticipated benefit in '08 or is that an annualized -

Ron Rittenmeyer - Chairman, President, CEO

No, that's the anticipated benefit in '08.

George Price - Stifel Nicolaus

Okay.

Ron Vargo - EVP, CFO

Yeah, we'd expect that to hit in '08.

George Price - Stifel Nicolaus

Okay. Thank you.

Operator

The next question comes from Adam Frisch with UBS. Please go ahead.

Adam Frisch - UBS

Thanks, guys. Just want to start off on the EPS question. I think the $1.35 is the right number considering the restructuring charges in the last several years, so I appreciate you doing that and clarifying it.

Ron Vargo, on the free cash flow situation in '08, the $900 million or so, it seems like a big number given the Verizon payment in '07 [inaudible] and EPS. Presumably the payout of severance which you talked about would be a little bit bigger in '08 related to restructuring.

So how does free cash flow get to $900 million, and are there going to be any chunky items in there like sometimes in the past, whether it's a building or asset sales or other one-timers that we should be aware of?

Ron Vargo - EVP, CFO

Yeah. The short answer is no. I agree with you, you know, $900 million on lower earnings, you kind of say where's it coming from? We had a significant use of working capital this year, as you know, and we think that's where most of the turnaround is going to be in terms of getting back to full $900 million.

Ron Rittenmeyer - Chairman, President, CEO

Yeah. You know, Adam, when I talked about execution, I mean, I think we have fairly good line of sight about what we've got to get done, and we're very focused on it.

So kind of like we talked about 55 days? I mean, that was done through execution.

Adam Frisch - UBS

Right.

Ron Rittenmeyer - Chairman, President, CEO

I don't want to overplay that card, but we are aware of that and, you know, I think it's a solid target. I don't think it's a target that I'm sitting back, you know what I'm saying, relaxed, that is a lay down? Hell, I didn't have that target for this year.

So I think we know the job in front of us, and our free cash flow tends to be a bit chunky and you know that. And I am very focused on improving the quality of this and not including things like asset sales without disclosing them.

Adam Frisch - UBS

Okay, cool.

Ron Rittenmeyer - Chairman, President, CEO

And being very aware of that. And so -

Adam Frisch - UBS

So the working capital changes are more like on lower deferreds and doing better on contract execution and stuff like that.

Ron Rittenmeyer - Chairman, President, CEO

Just a variety of things.

Ron Vargo - EVP, CFO

Yeah, payables, deferreds.

Ron Rittenmeyer - Chairman, President, CEO

A variety of things.

Ron Vargo - EVP, CFO

Things like that.

Hey, the other thing is, as you know and we reconcile for you in the back of this deck, we finance some capital, too, so, you know, it -

Ron Rittenmeyer - Chairman, President, CEO

And we're upfront about that.

Ron Vargo - EVP, CFO

And if we're looking at data center capital, we may do some sale and leasebacks if those make sense as well, and we'll be very upfront and disclose that if we do that.

Adam Frisch - UBS

That's what I was going to ask you. On Page 35, CFTs, is there going to be a material increase in '08 on those?

Ron Vargo - EVP, CFO

Hey, at first, you know, I'll be upfront. We like CFTs, right?

Ron Rittenmeyer - Chairman, President, CEO

Yeah.

Ron Vargo - EVP, CFO

We think they're the right thing to do. We think they - structured properly, they lay the risk off of EDS and help the overall deal economics by not putting our capital at risk.

So we're not forecasting a huge increase in CFTs, but on a deal-by-deal basis

Ron Rittenmeyer - Chairman, President, CEO

We're going to look at them.

Ron Vargo - EVP, CFO

I'll look at them, yeah.

Adam Frisch - UBS

Yeah, as well you should. I agree with that.

Ron Rittenmeyer - Chairman, President, CEO

And the other comment I want to make about this is also, you know, we're going to be very upfront with you guys talking about free cash flow on investments so, you know, to Ron's point, we're going to do the right kind of thing here. We're not going to make things, though, just to make free cash flow reported better if it doesn't make sense to the company, but we're going to disclose that, be very upfront about it, and talk about it.

Adam Frisch - UBS

Okay.

Ron Vargo - EVP, CFO

Yeah, go ahead.

Adam Frisch - UBS

Definitely welcome, guys. I just wanted to ask one last question. What would revenue growth be on a percentage basis without the Saber acquisition?

Ron Vargo - EVP, CFO

It'd probably be 1% to 2%.

Ron Rittenmeyer - Chairman, President, CEO

Yeah.

Adam Frisch - UBS

Okay, so it's not helping all that much? It's just adding about a point or so?

Ron Vargo - EVP, CFO

Yeah.

Ron Rittenmeyer - Chairman, President, CEO

I do - I have one other thing I want to talk about revenue too, you know. As I said last year, we are also looking at revenue relative to returns, so, I mean, in those numbers as we look at it, you know, there is some revenue that we're going to continue to investigate as to the quality of the revenue and whether we're getting enough for it and what that means to us.

Adam Frisch - UBS

Okay. Thanks a lot guys. I really appreciate it.

Ron Rittenmeyer - Chairman, President, CEO

Sure.

Ron Vargo - EVP, CFO

Thanks.

Operator

The next question comes from Jim Kissane from Bear Stearns. Please go ahead.

Jim Kissane - Bear Stearns

Yeah, thanks. Just following up on the working capital comments. Is the 55 days for DSOs sustainable? Is that the right number to use for '08?

Ron Vargo - EVP, CFO

We think it is. I think you'll see some volatility again, Jim, as you usually do in the first quarter because we have some structural events in the fourth quarter.

Last year we actually had, you know, a kick up in the DSO because of some terms with a couple of our customers which won't happen in 2008. So we think it's sustainable but, you know, my job is to try to make it sustainable from quarter to quarter to quarter. I know we'll have another volatile first quarter, but we're targeting 55 or better for year end 2008.

Ron Rittenmeyer - Chairman, President, CEO

And Ron's right. [inaudible]

Jim Kissane - Bear Stearns

And when you're done with the big cost action this year, will your cost structure be right sized or in sync with where the market is today, or do you expect, you know, further kind of big actions in '09, 2010?

Ron Vargo - EVP, CFO

Will our cost structure be right sized? Ron, you might want to kind of weigh in on this, but, you know, I think we will have a relentless focus on our costs year-over-year-over-year.

Ron Rittenmeyer - Chairman, President, CEO

Yeah. That's a broad question to just say yes -

Jim Kissane - Bear Stearns

I understand that's your business [inaudible]

Ron Rittenmeyer - Chairman, President, CEO

I mean the answer would --

Jim Kissane - Bear Stearns

I'm thinking about big - big action.

Ron Rittenmeyer - Chairman, President, CEO

Well, I guess I don't know where you're heading, but if you're saying are we going to do something - are you saying something material, something really - I can't answer that right now.

I can tell you that I am very - as a company, we are going to be focused on a couple things. One, we're going to be focused on closing deals that are of good quality, which includes being measured by free cash flow, which is a new measure we're putting in relative to how we develop and - I mean, when I say new measure, it was always there but it's now going to be a measure that gets looked at very hard.

We're also going to focus on least possible cost in terms of how we operate. So that's different than saying I want to be the lowest price, but it is - internally, we've got to think about every nickel that we spend and how we spend it. On the deal side, we've got to think about the value we bring and how to price it.

So there are two different categories that we're really focused and moving down the street on.

So I don't have anything specific to tell you, and I don't think this is the place to talk about other actions I'm going to take until I get ready to take them.

Jim Kissane - Bear Stearns

Okay, just following, just Ron, last thing, pricing on renewals and just pricing trends generally?

Ron Rittenmeyer - Chairman, President, CEO

Yeah. Pricing trends generally are always an exciting experience. I would say that clearly there's no - the horses aren't out of the barn in terms of prices going up rapidly, but I do think prices are relatively stable.

I haven't, you know, we're not having rapid declines in any specific area but, you know, pricing is always something that is - you know, I kind of look at pricing as the market's divided into two camps, you know? There's rational pricing that goes on in normal business, and then there's irrational pricing we see where sometimes the competition goes in with prices we don't know how the heck they got there from here.

We have walked away from some deals in the fourth quarter that we felt that the pricing was getting on the verge of irrational, and we're going to continue to do that. But I would say on balance I think the market's relatively stable.

Jim Kissane - Bear Stearns

Thanks, Ron.

Dave Kost - IR

Okay, Operator, we really only have time for one more call, or one more question, sorry.

Operator

This question comes from Bryan Keane with Credit Suisse. Please go ahead.

Bryan Keane - Credit Suisse

Yeah, hi. Just a couple of clarifications. I guess, Ron, the 2008 revenue growth at 2%, I guess, what's the organic growth number? I guess that I'm looking for ex acquisitions and ex currency. Is that about 1% for the year?

Ron Vargo - EVP, CFO

I'd say that's right, yeah, about 1%.

Bryan Keane - Credit Suisse

Okay. And then on Slide 30, I saw the U.S. government profit was down 34% year-over-year, and it said due to contractual price reduction. Can you just talk a little bit about that, what that looks like going forward?

Ron Rittenmeyer - Chairman, President, CEO

Well, I think it'll stable out. I mean, we should get some - we had a lot of signings this year. We had a lot of opportunities now because we've been allowed into a lot of opportunistic deals with the government. The next step then is to bid them and get them.

But the contract issue was, you know, we're going to - when we negotiate deals such as Navy, we negotiate into those deals certain price reductions, and then it's our job to figure out how to cover that cost and how to deal with that.

So some of those things take us awhile to actually implement because, you know, as changes occur in the contract, I mean, separating the cost factors take a little bit of time.

So, you know, within the Navy contract there was a price reduction and there were some others, but we have, you know, we sustain that and we understand it. And I think going forward we feel okay about it. It's still a contract that gets a heck of a return, and we're very comfortable with it.

Ron Vargo - EVP, CFO

Let me just add one thing to that, Ron. The quarter-over-quarter variance that you're looking at there was also impacted negatively by a couple of other items.

We had an incentive payment in the fourth quarter of '06 that didn't repeat at that level in '07. And we had some contract performance that will improve in 2008 from the fourth quarter 2007.

So I don't want you to kind of walk away thinking that, you know, that kind of difference is going to be reported every year or every quarter forward.

Bryan Keane - Credit Suisse

But it sounds like it will linger a little bit if you've renegotiated some of the price levels.

Ron Vargo - EVP, CFO

Oh, yeah. It'll linger. We don't forecast obviously contract - at the contract level for you. We don't even forecast at the region level. But there will be an impact, but it's not going to be nearly as big as this as you start looking out over full-year 2008.

Bryan Keane - Credit Suisse

Okay. And just a final question. I guess I was looking at the total contract value and you guys are saying that it slipped from 4Q into 1Q. I guess how much was that that you're down-selected on that got slipped that'll be pushed into the first quarter.

Ron Vargo - EVP, CFO

So what we've said was we had a number of contracts in which we were down-selected to one in the - and those contracts, several of them we expect to sign in the first quarter, others could linger during the year. We really don't quantify it, nor can we really kind of forecast what our first quarter TCV is going to be, but we think we'll have a good, strong first quarter.

Bryan Keane - Credit Suisse

Would you have hit your $21 to $23 billion guidance if those deals would have closed, I guess is what I'm -

Ron Rittenmeyer - Chairman, President, CEO

Well, look, the answer is probably we would have - yeah, we would have.

But I don't want to get into that in great detail, but yeah, had those - you know, it's an interesting statement. We're down-selected to one, now we've just got to get the contract, things could happen.

You know, there are a billion rules around how you report. Unfortunately not everybody reports the same in TCV, I've learned. I think TCV is a difficult thing to report when you're trying to get contracts on a quarterly basis. It ought to be looked at as a trending tool.

But generally speaking, yes, the answer is we would have hit our guidance.

Bryan Keane - Credit Suisse

Well, I guess I'm just a little surprised at the $20 billion guidance for 2008 considering you had some slippage into 1Q. I would have thought that $20 billion would have been a little bit higher.

Ron Rittenmeyer - Chairman, President, CEO

It could have been but, you know, you'll notice I said greater than $20 billion. It's hard when I'm dealing with numbers that - I'm dealing with some contracts that are billion-dollar contracts. And, you know, if I have to talk about something on a quarterly basis without, you know, and things move - and people write articles that talk about how our bookings are way down, then next quarter they write how they're way up.

I don't know exactly how to handle that in a realistic way with everybody except explain that these deals do move back and forth. First quarter could be great and, you know, fourth quarter next year we could have somewhat the same problem.

So you're dealing with a billion dollar - you know, there are a couple deals out there that are very big deals that, you know, if they don't sign by the end of March and it becomes April then - you know what I'm saying? It's just a - it's not a - it's a difficult thing to do on a quarterly basis.

Bryan Keane - Credit Suisse

Yeah. No, it might be helpful to look at bookings without renewals in it since sometimes those are the big chunky ones, and then we can get a better idea what the growth is.

Ron Rittenmeyer - Chairman, President, CEO

Dave Kost is smiling at me because we have that conversation quite frequently.

Bryan Keane - Credit Suisse

Okay. All right. Thanks a lot, guys.

Ron Vargo - EVP, CFO

Thanks.

Dave Kost - IR

Okay, so before we wrap up this call I want to remind everyone that we'll be holding our 2008 security analysts meeting in New York on February 19th. Be sure to call my office to register if you haven't already done so.

And with that, Operator, I'd like to thank everyone for joining us on the call today. I know some of you are still in the queue with questions. Feel free to call my office, and we'll be glad to talk them through.

Thanks very much.

Ron Rittenmeyer - Chairman, President, CEO

Thank you.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.

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