Annex Newsflash 2005-12                               April 7, 2005

IT SERVICES

Annex clients click here to view our detailed Accenture FY05 forecast

Updated 4/08/05, 8:00 AM PDT (adds "Stock Drops")

Analysis of Accenture's Second Quarter Fiscal 2005 Results

Roaring Ahead

But Stock Dips After Earnings Announcement

PHOENIX, Apr 7 Sometimes it's best to let the numbers speak for themselves.  When Accenture released its business results for the second quarter of its fiscal 2005 this afternoon after the markets closed, the stock shot up 4% in after-hours trading.  And no wonder.  If the company was "burning the track" (as we put it a year ago), it is roaring ahead now.

"We could not be more pleased with the top and the bottom line performance," said Bill Green, Accenture's CEO, during the teleconference that followed the earnings release.  He added that he was "particularly pleased" with financial services' and products' results, and with the momentum the company's consulting business has been building.

Revenues were up 15% to a record $3.81 billion in the second quarter, while net earnings surged by 70% to $210 million for a 5.5% net margin, up from 3.7% a year ago, exceeding Wall Street's expectations (EPS of $0.35 vs. $0.32 average forecast, and $0.22 last year).  

Furthermore, the company seems to be firing on all cylinders.  Led by Europe and financial services sectors, all five operating groups and all three geographic regions grew in the quarter, most in double digits.  Impressive!

Tarred with EDS' Brush?

And then came the earnings call.  Within minutes of Mike McGrath's (CFO) explanation of the problems the company is facing at Britain's National Health Service (NHS) account, the Accenture stock dropped by 2% notwithstanding its stellar second quarter results.  And that's where it remains as we write this.  Not even a positive spin that the CEO Bill Green put on the situation later on during the Q&A seemed to help much. 

McGrath disclosed that Accenture incurred losses of [only] $38 million in the first two quarters of this fiscal year.  Even the undeniable FACT that the company's operating profit surged by 54% to $472 million in the second quarter, including the NHS loss, failed to allay the investors' fears.

Shades of EDS' Navy contract must have been weighing heavily on investors' minds, we figure.  Nobody actually mentioned EDS by name during the Q&A session.  But some analysts did quiz Accenture executives about a possibility that the NHS malaise could develop into something more serious than just a flu, or growing pains.  The EDS/Navy aura was palpable.  And the initial 4% gain turned quickly into 2% drop in the Accenture stock price, as analysts focused on declining margins rather than rising profits.

A Case of "NHS Flu"

Accenture's second quarter gross margins fell to 30.8% from 33%, and the operating margins dropped from 12.6% to 11.4% (excluding restructuring benefits), hurt by deployment delays, cost-overruns and delivery inefficiencies.  The NHS contract was one of three reasons for it. 

McGrath said the NHS engagement would produce losses between $110 million and $150 million in the current fiscal year, and would continue do lose money for the company in FY06, albeit at a lower rate.  In FY07, however, McGrath expects the deal to return to profitability, and continue to be profitable for the remainder of the contract.  He refused to explain what the reason for the losses was.

That's when Green jumped in and said that, "this (NHS) is a terrific assignment... it's a ground-breaking assignment.  Our relationship with the customer is terrific."  

Sometimes when you do ground-breaking or pioneering work, you come up against surprises.  That was Green's implication.  But the rewards down the pike are likely to be substantial, too.  That was McGrath's hint.  That's because the company is developing reusable assets in this and several other deals of smaller magnitude that have contributed to cost-overruns and lower-than-expected margins.  

So one should think of the NHS and other current temporary losses as unplanned R&D expenses.  Eventually, they will pay off, and may pay off big.  But hoping that Wall Street would figure that out on its own is just too much to expect.  Accenture executives should have spelled that out, and then repeated it at least three times (once by each executive who participated in the call).  

Oh well... what's done, it's done.

Solid New Contract Bookings

New bookings totaled $4.88 billion, with consulting accounting for $2.81 billion and outsourcing accounting for $2.07 billion.  

"The pipeline (of new orders) remains strong in both consulting and outsourcing activities," Green said.  And Accenture is improving its win rates, too.  "The pricing has certainly stabilized," Green added.  Which bodes well for the company's future profit margins.

Great Return on Investment, Corporate Image

Meanwhile, Accenture's composite results, including the minor NHS losses, continue to look impressive in comparison to its Standard & Poor-peer companies.  Its return on net capital invested of 48%, for example, places Accenture as No. 2 among the S&M 500 companies.  Its return on equity and return on assets of 51% and 16% respectively, puts it in the No. 6 and No. 9 position on the list of America's largest corporations.

These and other superlative business attributes have also made it one of America's most admired companies.  Accenture ranks as No. 1 in the "Computer & Data Services" category on the latest Fortune list (yes, that's the category in which EDS ranks as dead last).

Outlook

Looking ahead, Accenture raised its fiscal 2005 guidance to a range of $1.49 to $1.53 a share, higher than its previous forecast of $1.41 to $1.46 a share.  The current average analyst estimate calls for earnings of $1.41 a share.  Accenture expects fiscal 2005 net revenue to be up 13% to 16%, and the new bookings in the $18 billion to $20 billion-range.

The company also offered an estimate for the fiscal third quarter, which ends in May. Accenture sees net income of 48 cents to 50 cents a share, which excludes a six-cents-a-share restructuring benefit, with net revenue in the range of $4.0 billion to $4.2 billion.

Accenture expects to add another 10,000 new employees to its payroll by the fiscal year end (Aug 31).  Given the declining attrition rates, would put its total employment as of the year end at about 120,000, according to Steve Rohleder, Accenture's COO.  Qualified employees are key component of Accenture's "global delivery system" that consists of over 40 delivery centers around the world, which the company claims is the industry first.

"My operational agenda is critical to our strategy of profitable growth," summed up Rohleder.  "I am confident that our focus on these areas will help us deliver our financial objectives."

Can't you hear the roar of a revved up engine?

Stock Drops "the Morning After"

PHOENIX, Apr 8 - After rising 4% at first in after-hours trading last night, the Accenture stock continued to drop "the morning after" on heavy volume notwithstanding the company's stellar second quarter results.  After about an hour of trading, it is down 6% this morning.  The 10% price swing has wiped out more than $2.2 billion of market cap.

Just how schizophrenically the market can sometimes behave can be illustrated by the following quote from this morning's Associated Press market summary:

Consulting firm Accenture Ltd. lost $1.28 to $23.61 after reporting strong revenues and profits for the quarter. The company's outlook for the current quarter and full year were in line with Wall Street estimates, though one-time benefits fueled some of Accenture's forecasts.

The contradiction between the positive verbiage and the negative result is obvious.  But does anyone care?  Evidently not on Wall Street, anyway.  Not when the herding instincts take over.

Happy bargain hunting!

Bob Djurdjevic

P.S. Annex clients click here to view our detailed Accenture FY05 forecast.

For additional Annex Research reports, check out... 

2005 IT:  Accenture: Roaring Ahead (Apr 2005); Fujitsu Unveils New Servers (Mar 2005);  EDS Executive Suite; HP's New CEO (Mar 2005);  An iSeries Revival (Mar 2005);  EDS Booster Club Fees Rise (Mar 2005);  An Upside-Down View (Mar 2005);   The Worst of Both Worlds (Mar 2005);   Octathlon 2005: Accenture Wins (Mar 2005);  IBM Global Services: Smaller, Shorter - Better? (Mar 2005);  IBM 5-yr Forecast: Quality over Quantity (Mar 2005); Rumor Lifts EDS', Fujitsu's Shares (Mar 2005); Capgemini: Turning the Corner (Feb 2005);  IBM Servers to Grow Again (Feb 2005);  Carly's Fickle Fans (Feb 2005);  CSC: Gearing Down on Purpose (Feb 2005);  EDS: Grossly Overpriced Stock (Feb 2005);  IBM Historical Update: 2004 Shot in the Arm (Feb 2005); New HeadTurners Series #1 (Feb 2005); IBM: A Crescendo Finale! (Jan 2005); Accenture: Strong Finish, Better Start (Jan 2005); Annex Coverage 2004: IT Services Dominate (Jan 2005)

2004 IT: EDS: The Titanium Stock (and other Wall Street tales) (Dec 2004); IBM PC: Good Riddance (Dec 2004); Fujitsu: Recovery Continues (Nov 2004);  IBM Server Renaissance (Nov 2004);  HP Hits Home Run (Nov 2004); Capgemini: Revenue, Stock Soars (Nov 2004); EDS: Jordan's Swan Song? (Nov 2004);  To Russia with Love and $ (Oct 2004); IBM: Slow Quarter No Longer (Oct 2004); Accenture: Revenues, Profits Up, Stock Down (Oct 2004); Capgemini: A Takeover Target? (Oct 2004); Sellout of America (Oct 2004); Spy Wars (Sep 2004); Outsourcing Boomerang (Sep 2004); EDS to Cut Up to 20,000 More Jobs (Sep 2004); Capgemini Stock Plummets on Unexpected Loss (Sep 2004); HP Savaged by Wall Street (Aug 2004); Moody's Lowers the Boon on EDS (July 2004); HP: Delivering Value Horizontally (June 2004); Accenture: Revving Up a Notch (June 2004); Beware Your CFO! (May 2004)IBM: Changing of the Guard (May 2004); Capgemini: Texas-size Home Run (May 2004); Following the Money (May 2004);  EDS: On a Wink and a Prayer (Apr 2004); HPS Wins by a Nose! (Octathlon 2004); Accenture: Burning the Track (Mar 2004);  IGS: "Crown Jewel" Restored? (Mar 2004); HP: Still No Cigar (Feb 2004); Cap Gemini: Another, Smaller Loss (Feb 2004); CSC: Good Quarter Gets Boos (Feb 2004); EDS: "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); IT Industry: Whither Goeth It? (Jan 2004); Cronyism Is Alive and Well at EDS" (Jan 2004)

Or just click on and use "financial engineering" or similar  keywords.

Volume XXI, Annex Newsflash 2005-12
April 7, 2005

Bob Djurdjevic, Editor
(c) Copyright 2005 by Annex Research, Inc. All rights reserved.
e-mail: annex@djurdjevic.com

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