IT Courts Government But At What Price?

As government agencies begin to more closely resemble their private sector counterparts, leading high-tech companies are beginning to go after government contracts more than ever before.

As a result, tech companies as large as Microsoft down to consulting firms as small as Burlington, Mass.-based Corridor Consulting are beefing up their presence inside or around the Beltway. In fact, the Redmond, Wash.-based software giant set up a new operations facility just last month in Reston, Va., around the corner from the headquarters of long-time rival AOL.

But as one IT services company recently learned, courting the federal government also has its downsides. Facing a possible Securities and Exchange Commission (SEC) inquiry and
questions about its cash position, IT services giant EDS
said it might ask the Navy to change the terms of the $6.9 billion IT
outsourcing deal inked two years ago.

EDS heralded the deal to construct the Navy Marine Corps Intranet as the largest
federal IT contract ever
. However, the huge deal has turned out to be a
short-term financial headache for EDS.

The company is seeking a two-year extension of the deal, in order to make up for 18 months of delays caused by Congressionally mandated testing requirements that went into effect after EDS won the contract. Because of the delays, the Plano, Tex., company has shouldered $640 million of ramp-up costs without receiving revenue from the deal, according to spokesman John Clendening.

“We are not currently renegotiating the terms and conditions of the contract,” he said. “There is a request for a two-year extension to the contract which has been working its way through Congress since February. We expect this extension to be authorized in the next few weeks.”

While Clendening said the deal would become cash-flow positive by next year, it is a drag on the company’s cash flow now. Thanks to the Navy deal and another large outsourcing deal with the United Kingdom government, EDS booked $731 million of revenues in the first two quarters of the year that had yet to be billed.

Investors have scrutinized EDS’ finances following the surprise
third-quarter revenue warning last month, when EDS announced it would widely
miss its revenue and profit targets.

On Tuesday, the company said the SEC had begun an informal inquiry of its
method of booking revenues of forward contracts, and CEO Richard Brown wrote
a letter to shareholders to reassure them that the company was on solid

“EDS remains a solid enterprise, with a strong business plan, excellent
people and great clients,” Brown wrote. “Your company is financially stable,
with the resources to fund ongoing business and take on new clients.”

EDS has said it faces no liquidity issues.

The problems arising from the government contract point to the downside to
dealing with the government, which much of the tech industry has turned to
as a reliable IT buyer as corporate spending continues to lag.

With researcher Gartner Group projecting tech spending to only inch up in
the next year, in contrast to 20 percent growth in 1999 and 2000, many tech
companies are turning to government projects to fill the gap. The government
continues to spend on technology, with over $50 billion of President Bush’s
proposed 2003 budget earmarked for IT spending. The new emphasis on domestic
security in the aftermath of the Sept. 11 attacks is expected to spur even
more tech spending, as disparate government agencies upgrade and link their
computer systems.

Government contracts accounted for 21 percent of EDS’ business in 2001, with large contracts making up for the recent IT industry downturn in so-called mega-deals of $500 million or more. Recently, EDS announced it was close to signing a $1.5 billion IT deal with Dutch bank ABN AMRO.

In his letter to shareholders, Brown said the company would alter its
strategy to deal with the current downturn. He said the company would cut
costs, in addition to concentrating on landing deals that will spur
immediate returns.

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