Long-Term Outlook Sparks EDS

The IT outsourcer's guidance for 2006 blows away analysts' estimates.
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Updated from 5:05 p.m. EDT

EDS

(EDS)

, which preannounced stronger-than-expected second-quarter results and raised full-year guidance last week, said Wednesday that 2006 earnings would far surpass analyst expectations.

For the first time, the Plano, Texas, IT-outsourcing company gave "directional" 2006 pro forma EPS guidance, pegging the measure at $1 or more. That's far higher than the 66-cents-a-share consensus estimate gathered by Thomson First Call.

The forecast boosted EDS shares nearly 8% in recent after-hours trading to $22.93, after they gained 3.7% to close at $21.29 in regular trading.

In addition to the earnings guidance, EDS said it expects free cash flow of $800 million to $1 billion in 2006, up from $500 million to $700 million in 2005.

The new target for earnings in 2006 represents a near doubling from 2005, when the company projects that pro forma earnings will range between 50 cents and 60 cents a share.

"I'd say we're more confident today than we were six months ago," CFO Bob Swan said in a postclose conference call. "The discretionary projects seem to be on an uptick."

The company decided to give 2006 earnings guidance earlier than usual because analysts were so far off the company's target, executives said.

Still, Jefferies analyst Joe Vafi noted a dollar per share in earnings is still "muted" compared with the company's business a few years ago. (He has an underperform rating on EDS and his firm hasn't done banking with the company.)

Additionally, Vafi said EDS is more a cash-flow story than an earnings story. And EDS is not forecasting that cash flow will double, he noted. The difference in cash flow and EPS trends could be caused by restructuring charges that the company is likely to take as its major customer,

General Motors

(GM) - Get Report

, subjects its work with EDS to competitive bidding next year, Vafi said.

But "all that said, it does say it is gaining some momentum," he acknowledged.

In fact, UBS analyst Adam Frisch noted on the conference call that free cash flow in 2005 will benefit from a couple of one-time events, including a $200 million real estate sale. That suggests the company is setting the bar for free cash flow growth in 2006 even higher than it might first appear, prompting him to join a chorus of analysts who asked the company why it's so confident.

On the call, EDS executives repeatedly attributed their confidence to improved productivity in the company's massive contract with the U.S. Navy, which they believe will more than offset any loss in business from GM.

That said, CEO Mike Jordan said he's also optimistic about EDS' chances of remaining a significant service provider to GM, which he expects to make final decisions at the end of the year and sign contracts at the beginning of 2006.

"Our progress in bolstering productivity and improving the performance of our large outsourcing contracts, including the U.S. Navy Marine Corps Intranet, drove substantial earnings, margin and free cash flow improvement," Jordan said in a statement.

"We expect this trend to continue, delivering significant EPS and free cash flow improvement in the second half of 2005 and for full-year 2006," he said.

EDS executives said productivity initiatives companywide also will more than offset pricing pressures and restructuring charges. EDS expects its operating margin to expand to 5% in 2006 from 2.7% this year. The company expects total contract value to increase to roughly $21 billion in 2006 from $20 billion in 2005.

For the second quarter, EDS is expecting earnings of 10 cents to 15 cents a share on sales of $4.8 billion to $5 billion. The midpoint of that guidance falls short of analyst expectations calling for earnings of 14 cents a share on $5.1 billion in sales.

In addition, the company's bookings of $2.8 billion in the quarter were more than $1 billion short of some expectations. Jordan indicated at least one major contract slipped out into August.

Still, the company's stunning 2006 earnings guidance comes less than a week after EDS

surprised investors Friday with its strong second-quarter results and new guidance for 2005. The company elaborated on those results Wednesday.

EDS reported second-quarter earnings of $26 million, or 5 cents a share, and a profit before items of $45 million, or 9 cents a share, for the quarter. That compared with earnings of $270 million, or 54 cents a share, a year earlier, and a loss before items of $16 million, or 3 cents a share, a year earlier.

Thomson First Call had a consensus estimate for the second quarter of a loss of 5 cents a share when the company preannounced last week; the company's guidance called for a loss of 2 cents to 7 cents a share.

Earnings before items exclude costs of 6 cents for stock-option expensing and the issuance of performance-based restricted stock units. This measure also excludes a gain of 2 cents a share from prior-year divestitures, discontinued operations and the reversal of a portion of previously recognized restructuring expenses.

Both actual earnings and the profit before items will include an asset-impairment charge of 5 cents a share associated with a commercial contract disclosed in June. At that time, the company held assets of $166 million in support of the contract and said a significant portion or all of the assets might be impaired.

Second-quarter revenue totaled $5.2 billion, at the high end of its previous guidance. That was down from sales of $5.24 billion a year earlier. Analysts' latest model called for sales of $5.11 billion.

Revenue from General Motors decreased 6% from a year ago to $447 million.

On Friday, EDS also said earnings before items for the full year would be 10 cents better than anticipated, with the new range between 50 cents and 60 cents a share. EDS still sees total contract signings with a value of around $20 billion for the full year and projected revenue for the year would range from $20 billion to $21 billion.

For the full year, analysts were most recently expecting earnings of 45 cents a share on sales of $20.3 billion.