As scrutiny over companies' accounting practices continues to intensify in the wake of Enron's collapse, IT vendors are trying hard to calm financial concerns from investors, analysts and clients. Following this trend, top executives from Electronic Data Systems (EDS), one of the world's largest IT services providers, devoted considerable time during a meeting with financial analysts this week to defend its accounting practices.
A Wall Street Journal article last year highlighted concerns from some investors and analysts over several EDS financial issues. The issues included an accounting practice called off-balance-sheet financing, now in the spotlight because bankrupt Enron engaged in it.
The Journal article, which ran in late December, caused enough of an uproar that some analysts blamed it for causing a drop in EDS' share price. At the time, EDS officials and some independent analysts dismissed the concerns raised in the article, saying, among other things, that there was no way of comparing Enron's and EDS' use of off-balance-sheet financing. Enron used the practice to hide billions of dollars in debt that eventually sank the company.
EDS' top guns recently tackled the accounting concerns head on.
"Our accounting practices are conservative, concise and complete. We have no hidden liabilities and no hidden debt," Dick Brown, the company's chairman and chief executive officer, said during the meeting with financial analysts that was held in the company's Texas headquarters and broadcast over the Web. "It's important you know beyond a doubt that you really have no reason to be apprehensive."
Jim Daley, executive vice president and chief financial officer, also addressed the accounting concerns, even contesting the Journal article's premise that EDS engages in off-balance-sheet financing.
"What we call client financing transactions, or CFTs, and others call off-balance-sheet financing, are a sound financial practice and don't represent hidden risk to EDS. Literally, in the conventional sense of off-balance-sheet financing, this is not what [a CFT] is," he said.
Off-balance-sheet financing occurs when a company raises capital through certain avenues, such as joint ventures, partnerships and leases, to prevent the financing from appearing as a liability in the company's balance sheet.
EDS arranges CFTs in some service contracts that require the purchase of IT equipment. EDS links clients with independent financial institutions willing to finance the purchase, officials said. Sometimes the equipment in question is new, and sometimes the equipment is already owned by the client, an EDS spokesman said on Wednesday. In the latter case, the equipment is bought by the bank and leased back to the client, the spokesman said.
"CFTs are transactions between independent financial institutions and our clients. Those are the two parties to the transaction," Daley said.
As part of CFT agreements, EDS is only obligated to acquire the equipment being financed if the client is unhappy with EDS' performance and terminates the contract, Daley said. EDS began arranging this type of financing in 1995. Since then, it has arranged $US2.8 billion in CFTs, and has had to buy $30 million -- about 1 per cent, he said. EDS currently has about $900 million in outstanding CFTs, Daley said.
The practice carries no additional risk for EDS than a traditional scenario in which EDS itself would buy the equipment called for in the services contract, he said. In that case, EDS would also have to absorb the cost of the equipment it had bought up front if the client were to pull out of the contract due to non-performance on EDS' part, Daley said.
The CFT practice carries various benefits to EDS and its clients, he added. For example, clients get a more favourable financing rate from the financial institutions than they would from EDS, while EDS transfers the credit risk to the financial institution and preserves capital, he said. EDS has always disclosed its obligation to acquire CFT assets in its financial statements, Daley said.
In a note published on Tuesday, two Salomon Smith Barney analysts who attended the meeting wrote that the off-balance-sheet financing is a non-issue.
"What we have here is two separate contracts: One is a service contract between EDS and its client, the other is a sale/leaseback-type of agreement between the client and its financial institution. EDS has no liability, except in the event of non-performance by EDS on the contract. EDS' track record in this regard is good," reads the note authored by Patrick M. Burton and Ashwin Shirvaikar.
The analysts point out that EDS receives "no direct financial benefit or 'cut' even when it recommends a financial institution". It benefits indirectly by transferring the credit risk, preserving capital and reducing cost for the client, who gets lower financing rates, the analysts wrote.
Moreover, using off-balance-sheet financing keeps revenue out of the company's financial statement.
"In terms of financial statement impact, if EDS did not use off-balance sheet financing, it would have higher revenues, lower overall margins (since equipment financing margins are lower than outsourcing margins) and slightly higher EPS (because of higher profits in dollar terms, associated with the incremental equipment financing revenues)," the note reads.