ACS Beats Marginally

Affiliated Computer Services, Inc. (ACS - Analyst Report) reported pro forma earnings of 95 cents per share, an increase of 6 cents per share from the same quarter a year ago and beating the Zacks Consensus Estimate by a penny.

Total revenue increased 5% to $1.68 billion from the year-ago quarter, including internal revenue growth of 2%. The increase in revenue was driven by strength in both the Commercial and Government segments.

The Commercial segment contributed 61% of revenues and grew 6% year over year, with internal growth of 2%. The Government segment contributed 39% of revenues and grew 2%, all of which were from internal growth.

Adjusted non-GAAP operating income was $162 million or 9.7% of total revenue in the quarter compared to $178 million or 11.1% of total revenue in the year-ago period. Operating income was negatively affected by deferred compensation costs of approximately $9 million or 50 basis points.

Moreover, ACS recorded a charge of $18.1 million related to the merger with Xerox Corp. (XRX) and $11.2 million related to the employment agreement with Mr. Darwin Deason (the company’s Chairman).

The company’s new business signings totaled approximately $212 million of annual recurring revenue (ARR) amounting to an estimated contract value of $833 million. Total contract value of all signings, including new business signings, renewals and non-recurring revenue was $1.5 billion in the quarter. Signings were strong in the commercial segment, which represented 71% of new business signings. The Government segment contributed 29%.

Operating Performance
The company used $21 million cash from operations in the first quarter, versus $63 million cash generated in the year-ago quarter. Free cash flow of $149 million was used in the quarter versus $11 million used in the year-ago period.

The company exited the September quarter with $558.8 million in cash and cash equivalents, versus $730.9 million generated in the previous quarter. The company had $2.32 billion in long term debt at the end of the quarter versus $2.34 billion in the previous quarter.

Xerox-ACS Merger
On September 27, Xerox Corp. agreed to acquire ACS in a cash and stock transaction valued at $6.4 billion ($63.11 per ACS share). This represents a 33.6% premium to the closing price of ACS on September 25, which was $47.25 per share. The transaction is expected to be accretive to the combined company in fiscal 2010. Trading currently below the acquisition price, we believe the deal to be beneficial for Affiliated.

Affiliated shareholders will receive $18.60 per share in cash and 4.935 shares of Xerox. Xerox will also assume $2 billion of ACS’s debt and will issue $300 million of convertible preferred stock.

Due to the expected merger, ACS did not provide financial guidance for the second quarter or fiscal year 2010.

We have a Neutral rating on ACS stock.