EDS' fortunes could hinge on option years

Not long after it was awarded in October 2000, the Navy-Marine Corps Intranet contract turned into a financial and practical drag on Electronic Data Systems Corp.

A simple Google search on the terms 'EDS,' 'NMCI' and 'financial' turn up more than 4,500 hits. Unlike most government contracts, no matter how big, this one has made it into the mainstream consciousness.

'When you put the word 'NMCI' before any other agency, it's kind of a Rorschach test'what you get is not, 'Boy, that was a good program.' It's 'Boy, it's been troubled ever since the beginning,' ' said Warren Suss of Suss Consulting Inc. of Jenkintown, Pa.

Before the award, EDS stock was trading in the $40 to $50 range per share. After the win, it rose as high as $71.88 in November 2001. But as bad news about the cost and difficulty of the contract was released, the stock price fell as low as $11.27 in October 2002, almost exactly two years from the contract announcement. As of June 9, shares were trading just over $19.

EDS chairman Dick Brown was fired in March 2003 because of the financial disaster NMCI brought on the company. In the fourth quarter of 2003 alone, EDS had to write down almost $560 million in deferred costs related to the project, while in 2004 it lost more than $420 million on the contract. Meanwhile, a class action lawsuit filed by disgruntled shareholders continues to work its way through a U.S. District Court in Texas.

Throughout these travails, the company has counted on the contract's option years. The $8.8 billion contract has a seven-year base period, with a single three-year option. EDS executives and financial analysts alike have said repeatedly that the company will begin to recoup its huge up-front investment when the option is exercised.

'From what I understand, they're making money on [the contract] right now,' said one industry executive familiar with the program. 'Their cash flow has turned positive on a month-by-month basis, but there's all that debt they've got to cover.'

NMCI's troubles could jeopardize EDS' opportunity to keep the contract for the three-year option.
'As with any of these deals, if you don't win the minds and hearts of that customer before the option years hit, you're vulnerable to losing it,' Suss said. 'You can't fault the Navy for considering whether or not to exercise the option.'

And the company may have lost out in another way.

'EDS had [the] opportunity to position itself more broadly within DOD, to expand its positioning from the Navy to the company that owned the first, watershed deal,' he said. 'On both fronts, I can't say they failed, but I certainly can't say they succeeded.'

So what might it mean to EDS if the Navy decides to recompete the contract in 2007, rather than exercise the option?

'This would not be a psychological black eye in the marketplace, just the reality of working in that world of large contracts,' said Kevin DeSanto, a vice president with the Aerospace Defense Government Group at Houlihan, Lokey, Howard and Zukin of McLean, Va.

Large contracts aren't going to be easy or always run smoothly, he said. 'I think they should be proud of what they've been able to accomplish. They have used that [NMCI] already to win that big U.K. defense contract,' he said, referring to a $4 billion, 10-year contract awarded earlier by the United Kingdom's Ministry of Defence.

But that doesn't mean EDS is sanguine with any possible scenario.

'Let's just say the company would be 'irritated' if it gets recompeted,' said one EDS official.

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