| ELECTRONIC DATA SYSTEMS CORP /DE/ ITEM 1A RISK FACTORS Because of the following factors, as well as other variables affecting our operating results, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods |
| Our engagements with clients may not be profitable |
| The pricing and other terms of our client contracts, particularly our long-term IT outsourcing agreements, require us to make estimates and assumptions at the time we enter into these contracts that could differ from actual results |
| These estimates reflect our best judgments regarding the nature of the engagement and our expected costs to provide the contracted services |
| Any increased or unexpected costs or unanticipated delays in connection with the performance of these engagements, including delays caused by factors outside our control, could make these contracts less profitable or unprofitable, which would have an adverse effect on our profit margin |
| Our exposure to this risk increases generally in proportion to the scope of the client contract |
| In addition, a majority of our IT outsourcing contracts contain some fixed-price, incentive-based or other pricing terms that condition our fee on our ability to meet defined goals |
| Our failure to meet a client’s expectations in any type of contract may result in an unprofitable engagement |
| Our ability to recover significant capital investments in certain construct contracts is subject to risks |
| Some of our client contracts require significant investment, including asset purchases and operating losses, in the early stages which is recovered through billings over the life of the respective contract |
| These contracts often involve the construction of new computer systems and communications networks and the development and deployment of new technologies |
| Substantial performance risk exists in each contract with these characteristics, and some or all elements of service delivery under these contracts are dependent upon successful completion of the development, construction and deployment phases |
| Contracts with ongoing construct activities had assets, including receivables, prepaid expenses, deferred costs, equipment and software, of approximately dlra1dtta3 billion at December 31, 2005, including approximately dlra0dtta9 billion associated with the NMCI contract (net of impairment charges associated with this contract in previous years) |
| Some of these contracts, including the NMCI contract, have experienced delays in their development and construction phases, and certain milestones have been missed |
| We refer you to the discussion of the NMCI contract under “Overview – 2005 Highlights” below for further information regarding our risks under such contracts |
| Remaining long-lived assets and lease receivables associated with the NMCI contract totaled dlra240 million and dlra408 million, respectively, at December 31, 2005 |
| In addition, we refer you to the discussion under “Overview – 2005 Highlights” below for further information regarding our risks under a commercial contract for which we recognized a dlra37 million non-cash impairment charge in 2005 |
| Our exposure to certain industries and financially troubled customers has adversely affected our financial results |
| Our exposure to certain industries and financially troubled customers has had, and could in the future have, a material adverse effect on our financial position and our results of operations |
| For example, we are a leading provider of IT outsourcing services to the United States automobile industry, which sector has been experiencing significant financial difficulties |
| We refer you to the discussion under “Overview” below of our revenues from GM and reserves recorded in 2005 with respect to our receivables from Delphi, which filed for bankruptcy in October 2005 |
| In addition, we are the leading IT outsourcing provider to the airline industry, which has also faced significant financial challenges |
| We have a long-term IT outsourcing agreement with American Airlines and recently entered into a long-term IT outsourcing agreement with United Airlines |
| We also provide IT services to US Airways, which filed for bankruptcy in September 2004 |
| We refer you to the discussion in Note 5 of the notes to our consolidated financial statements below of the write-down of our investment in an aircraft leasing partnership due to uncertainties regarding the recoverability of the partnership’s investments in aircraft leased to Delta Air Lines, which filed for bankruptcy in September 2005 |
| 5 ______________________________________________________________________ A decline in revenues from or loss of significant clients could reduce our revenues and profitability |
| Our success is to a significant degree dependent on our ability to retain our significant clients and maintain or increase the level of revenues from these clients, including in particular revenues from certain “mega-deal” long-term IT outsourcing agreements |
| We may lose clients due to their merger or acquisition, business failure, contract expiration, conversion to a competing service provider or conversion to an in-house data processing system |
| We may not be able to retain or renew relationships with our significant clients in the future |
| As a result of business downturns or for other business reasons, we are also vulnerable to reduced processing volumes from our clients, which can reduce the scope of services provided and the prices for those services |
| Impact of Rating Agency downgrades |
| Any adverse action by Moody’s, S&P or Fitch with respect to our long-term credit ratings could materially adversely impact our ability to compete for new business, our cost of capital and our ability to access capital |
| Some of our contracts contain benchmarking provisions that could decrease our revenues and profitability |
| Some of our long-term IT outsourcing agreements contain pricing provisions that permit a client to request a benchmark study by a mutually acceptable third-party benchmarker |
| Typically, benchmarking may not be conducted during the initial years of the contract term but may be requested by a client periodically thereafter, subject to restrictions which limit benchmarking to certain groupings of services and limit the number of times benchmarking may be elected during the term of the contract |
| Generally, the benchmarking compares the contractual price of our services against the price of similar services offered by other specified providers in a peer comparison group, subject to agreed upon adjustment and normalization factors |
| Generally, if the benchmarking study shows that our pricing has a difference outside a specified range, and the difference is not due to the unique requirements of the client, then the parties will negotiate in good faith any appropriate adjustments to the pricing |
| This may result in the reduction of our rates for the benchmarked services |
| Due to the enhanced focus of our clients on reducing IT costs, as well as the uncertainties and complexities inherent in benchmarking comparisons, our clients may increasingly attempt to obtain additional price reductions beyond those already embedded in our contract rates through the exercise of benchmarking provisions |
| Such activities could negatively impact our results of operations or cash flow in 2006 or thereafter to a greater extent than has been our prior experience |
| An ongoing SEC investigation could adversely affect us or the market value of our securities |
| The SEC staff is conducting a formal investigation of some of our activities and contracts |
| We refer you to the discussion of “Pending Litigation and Proceedings” under Note 15 of the notes to our consolidated financial statements below for a description of this investigation |
| The investigation is ongoing, and we will continue to cooperate with the SEC staff |
| We are unable to predict the outcome of the investigation, the scope of matters that the SEC may choose to investigate in the course of this investigation or in the future, the SEC’s views of the issues being investigated, or any action that the SEC might take, including the imposition of fines, penalties, or other available remedies |
| Any adverse development in connection with the investigation, including any expansion of the scope of the investigation, could have a material adverse effect on us, including diverting the efforts and attention of our management team from our business operations, and could negatively impact the market value of our securities |
| Pending litigation could have a material adverse effect on our liquidity and financial condition |
| We are defendants in various claims and pending actions arising in the ordinary course of business or otherwise |
| We recently agreed upon the terms of a settlement regarding certain shareholder class action suits and remain a party to certain other litigation related to such matters |
| We refer you to the discussion of “Pending Litigation and Proceedings” under Note 15 of the notes to our consolidated financial statements below for a description of certain of these matters |
| We are not able to determine the actual impact of these matters on us or our consolidated financial statements |
| However, we may be required to pay judgments or settlements and incur expenses in aggregate amounts that could have a material adverse effect on our liquidity and financial condition |
| The markets in which we operate are highly competitive, and we may not be able to compete effectively |
| The markets in which we operate include a large number of participants and are highly competitive |
| Our primary competitors are IT service providers, large accounting, consulting and other professional service firms, application service providers, telecommunications companies, packaged software vendors and resellers and service groups of computer equipment companies |
| We also experience competition from numerous smaller, niche-oriented and regionalized service providers |
| Our business is experiencing rapid changes in its competitive landscape |
| We increasingly see our competitors moving operations offshore to reduce their costs as well as increasing direct competition from niche offshore providers, primarily India-based competitors |
| The competition from India-based companies is growing in intensity due to the abundance of highly skilled workers in the country, a pro-business regulatory environment and significantly lower costs of labor, which may allow these competitors to offer lower prices than we are able to offer |
| In addition, negative publicity from our pending litigation or SEC staff investigation could have a negative effect on our competitive position |
| Any of these factors may impose additional pricing pressure on us, which could have an adverse effect on our revenues and profit margin |
| 6 ______________________________________________________________________ Market changes may result in decreased profitability |
| The IT outsourcing market is commoditizing, which is shrinking margins on many of our core offerings |
| In addition, that market has experienced slower growth and lower margins in recent years |
| We are continuing to invest in new service offerings in the higher-margin segments such as Business Process Outsourcing and applications development |
| However, if we are unable to implement our strategies to more effectively compete in such markets, our margins and profitability could be adversely affected |
| Management has implemented a multi-year plan designed to make significant changes in the way we do business |
| This plan includes the development of a new technology platform for the delivery of our services which we refer to as the “Agile Enterprise” as well as other initiatives intended to substantially reduce our cost structure |
| We invested significant capital in the implementation of the multi-year plan in 2005 and will invest additional capital in 2006 |
| Although management believes this plan will enable us to achieve sustainable, profitable growth over the longer term, there can be no assurance as to the acceptance of our technology initiatives in the marketplace or our ability to recognize a return on our investment |
| Our ability to achieve the anticipated cost savings and other benefits from these initiatives on a timely basis is subject to many estimates and assumptions, including assumptions regarding the costs and timing of activities in connection with these initiatives |
| These estimates and assumptions are subject to significant economic, competitive and other uncertainties some of which are beyond our control |
| In addition, service pricing contained in certain contracts signed since early 2005, including our new contracts with GM and the UK Government’s Department of Works and Pension, and other contracts expected to be signed in 2006, assume successful completion of our EDS Agile Enterprise initiatives on a timely basis |
| If these assumptions are not realized and we experience delays beyond those already experienced with respect to certain segments of these initiatives, or if other unforeseen events occur, our business and results of operations could be adversely affected and there could be a material adverse effect on the price of our securities |
| Unanticipated changes in our tax provisions or exposure to additional tax liabilities could affect our profitability |
| We are subject to income taxes in the United States and numerous foreign jurisdictions |
| We are subject to ongoing tax audits in various jurisdictions |
| Tax authorities may disagree with our intercompany charges or other matters and assess additional taxes |
| Our provision for income taxes and cash tax liability in the future could be adversely affected by numerous factors including, but not limited to, income before taxes being lower than anticipated in countries with accumulated tax losses and higher than anticipated in countries with higher statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, regulations, accounting principles or interpretations thereof, and the discovery of new information in the course of our tax return preparation process, which could adversely impact our results of operations and financial condition in future periods |
| In particular, the carrying value of deferred tax assets is dependent on our ability to generate future taxable income over the expiration period of the tax asset |
| An impairment of deferred tax assets would result in an increase in our effective tax rate and related tax expense in the period of impairment and could affect our profitability |
| Risks associated with our international operations could negatively affect our earnings |
| International operations accounted for approximately one-half of our revenues in 2005 and will continue to represent a significant opportunity for growth in the IT industry |
| Our results of operations are affected by our ability to manage risks inherent in doing business abroad |
| These risks include exchange rate fluctuation, regulatory concerns, terrorist activity, restrictions with respect to the movement of currency, access to highly skilled workers, political and economic instability and our ability to protect our intellectual property |
| Any of these risks could impede our ability to increase our presence in certain jurisdictions or enter new jurisdictions |
| In addition, these risks could result in increased costs which could materially adversely affect our results of operations |
| Our services or products may infringe upon the intellectual property rights of others |
| We cannot be sure that our services and products, or the products of others that we offer to our clients, do not infringe on the intellectual property rights of third parties, and we may have infringement claims asserted against us |
| These claims may harm our reputation, cost us money and prevent us from offering some services or products |
| We generally agree in our contracts to indemnify our clients for any expenses or liabilities they may incur resulting from claimed infringements of the intellectual property rights of third parties |
| In some instances, the amount of these indemnities may be greater than the revenues we receive from the client |
| Any claims or litigation in this area, whether we ultimately win or lose, could be time-consuming and costly, injure our reputation or require us to enter into royalty or licensing arrangements |
| We may, in limited cases, be required to forego rights to the use of intellectual property we help create, which limits our ability to also provide that intellectual property to other clients |
| Any limitation on our ability to provide a service or product could cause us to lose revenue-generating opportunities and require us to incur additional expenses to develop new or modified solutions for future projects |
| A material weakness in our internal controls could have a material adverse effect on us |
| Effective internal controls are necessary for us to provide reasonable assurance with respect to our financial reports and to effectively prevent fraud |
| If we cannot provide reasonable assurance with respect to our financial reports and effectively prevent fraud, our reputation and operating results could be harmed |
| Pursuant to the Sarbanes-Oxley Act of 2002, we are required to furnish a report by management on internal control over financial reporting, including management’s assessment of the effectiveness of such control |
| Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud |
| Therefore, even effective internal controls can provide only 7 ______________________________________________________________________ reasonable assurance with respect to the preparation and fair presentation of financial statements |
| In addition, projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that the control may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate |
| If we fail to maintain the adequacy of our internal controls, including any failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business and operating results could be adversely impacted, we could fail to meet our reporting obligations, and there could be a material adverse effect on our stock price |
| In connection with their review of our third quarter 2004 results and the ongoing procedures related to their audit of internal controls over financial reporting as of December 31, 2004, our independent auditors identified material weaknesses in our internal controls related to our NMCI contract and revenue recognition |
| Although such material weaknesses were corrected by December 31, 2004, we may identify one or more material weaknesses in our internal control over financial reporting from time to time in the future |
| Cautionary Statement Regarding Forward-Looking Statements The statements in this Report that are not historical statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 |
| These forward-looking statements include statements regarding estimated revenues, earnings, free cash flow, total contract value (“TCV”) of new contract signings, operating margins, cost savings and other forward-looking financial information |
| In addition, we have made in the past and may make in the future other written or oral forward-looking statements, including statements regarding future financial and operating performance, short- and long-term revenue, earnings and free cash flow, the timing of the revenue, earnings and free cash flow impact of new and existing contracts, liquidity, estimated future revenues from existing clients, the TCV of new contract signings, business pipeline, industry growth rates and our performance relative thereto, the impact of acquisitions and divestitures, and the impact of client bankruptcies |
| Any forward-looking statement may rely on a number of assumptions concerning future events and be subject to a number of uncertainties and other factors, many of which are outside our control, that could cause actual results to differ materially from such statements |
| In addition to the factors outlined above, these factors include, but are not limited to, the following: the performance of current and future client contracts in accordance with our cost, revenue and cash flow estimates, including our ability to achieve any operational efficiencies in our estimates; for contracts with US Federal government clients, including our NMCI contract, the government’s ability to cancel the contract or impose additional terms and conditions due to changes in government funding, deployment schedules, military action or otherwise; our ability to access the capital markets, including our ability to obtain capital leases, surety bonds and letters of credit; the impact of third-party benchmarking provisions in certain client contracts; the impact on a historical and prospective basis of accounting rules and pronouncements; the impact of claims, litigation and governmental investigations; the success of our multi-year plan and cost-cutting initiatives and the timing and amount of any resulting benefits; the impact of acquisitions and divestitures; a reduction in the carrying value of our assets; the impact of a bankruptcy or financial difficulty of a significant client on the financial and other terms of our agreements with that client; with respect to the funding of pension plan obligations, the performance of our investments relative to our assumed rate of return; changes in tax laws and interpretations and failure to obtain treaty relief from double taxation; failure to obtain or protect intellectual property rights; fluctuations in foreign currency, exchange rates and interest rates; the impact of competition on pricing, revenues and margins; and the degree to which third parties continue to outsource IT and business processes |
| We disclaim any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except as may be required by law |