##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark One)  [X]
    Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 2004 or  [   ]
    Transition Report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the transition period
from                to Commission File Number 0-22495 PEROT SYSTEMS CORPORATION  DELAWARE
    
    75-2230700(State or other jurisdiction of
    
    (IRS Employerincorporation or organization)
    
    Identification No.)
 2300 WEST PLANO PARKWAY
PLANO, TEXAS
75075
(Address of principal executive offices)
(Zip Code) (972) 577-0000
(Registrants telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X]Yes  [   ]No Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
[X]Yes   [   ]No Number of shares of registrants common stock outstanding as of October 29,
2004: 112,969,128 shares of Class A Common Stock and 3,275,012 shares of Class
B Common Stock.




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
FORM 10-Q
For the Quarter Ended September 30, 2004 INDEX
    
    
    
    PagePART I:
    
    FINANCIAL INFORMATIONITEM 1:
    
    FINANCIAL STATEMENTS (UNAUDITED)Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003
    
    
    1Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2004 and 2003
    
    
    2Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4ITEM 2:
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    15ITEM 3:
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    29ITEM 4:
    
    CONTROLS AND PROCEDURES
    
    
    29PART II:
    
    OTHER INFORMATIONITEM 1:
    
    LEGAL PROCEEDINGS
    
    
    30ITEM 4:
    
    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    31ITEM 6:
    
    EXHIBITS AND REPORTS ON FORM 8-K
    
    
    31SIGNATURES
    
    
    
    
    33Rule 13a-14 Certification of President and CEORule 13a-14 Certification of Vice President and CFOSection 1350 Certification of President and CEOSection 1350 Certification of Vice President and CFO




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##### Table of Contents



ITEM 1: FINANCIAL STATEMENTS (UNAUDITED) PEROT SYSTEMS CORPORATION AND SUBSIDIARIES 
   
 September 30, 2004
    
    December 31, 2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    230,199
    
    
    $
    123,770Short-term investments
    
    
    
    
    
    
    37,599Accounts receivable, net
    
    
    234,873
    
    
    
    208,244Prepaid expenses and other
    
    
    68,131
    
    
    
    52,370Total current assets
    
    
    533,203
    
    
    
    421,983Property, equipment and purchased software, net
    
    
    141,577
    
    
    
    142,836Goodwill
    
    
    359,336
    
    
    
    347,576Other non-current assets
    
    
    130,499
    
    
    
    98,202Total assets
    
    $
    1,164,615
    
    
    $
    1,010,597LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current portion of long-term debt
    
    $
    75,498
    
    
    $
    Accounts payable
    
    
    37,970
    
    
    
    27,063Accrued liabilities
    
    
    82,801
    
    
    
    98,021Other current liabilities
    
    
    119,128
    
    
    
    81,959Total current liabilities
    
    
    315,397
    
    
    
    207,043Long-term debt
    
    
    
    
    
    
    75,498Other non-current liabilities
    
    
    26,382
    
    
    
    15,277Total liabilities
    
    
    341,779
    
    
    
    297,818Stockholders equity:Common stock
    
    
    1,158
    
    
    
    1,123Additional paid-in capital
    
    
    462,814
    
    
    
    421,847Retained earnings
    
    
    355,864
    
    
    
    288,615Other stockholders equity
    
    
    (4,813
    )
    
    
    (4,174
    )Accumulated other comprehensive income
    
    
    7,813
    
    
    
    5,368Total stockholders equity
    
    
    822,836
    
    
    
    712,779Total liabilities and stockholders equity
    
    $
    1,164,615
    
    
    $
    1,010,597
 The accompanying notes are an integral part of these financial statements. Page 1




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES 
     Three months ended September 30,
    
    Nine months ended September 30,2004
    
    2003
    
    2004
    
    2003Revenue
    
    $
    454,290
    
    
    $
    371,330
    
    
    $
    1,307,888
    
    
    $
    1,067,732Direct cost of services
    
    
    356,256
    
    
    
    301,447
    
    
    
    1,036,785
    
    
    
    880,786Gross profit
    
    
    98,034
    
    
    
    69,883
    
    
    
    271,103
    
    
    
    186,946Selling, general and administrative expenses
    
    
    62,058
    
    
    
    46,916
    
    
    
    170,072
    
    
    
    137,322Operating income
    
    
    35,976
    
    
    
    22,967
    
    
    
    101,031
    
    
    
    49,624Interest income
    
    
    625
    
    
    
    567
    
    
    
    1,361
    
    
    
    1,865Interest expense
    
    
    (537
    )
    
    
    (51
    )
    
    
    (1,512
    )
    
    
    (74
    )Equity in earnings of unconsolidated affiliates
    
    
    
    
    
    
    1,681
    
    
    
    
    
    
    
    4,722Other income (expense), net
    
    
    651
    
    
    
    589
    
    
    
    355
    
    
    
    2,113Income before taxes
    
    
    36,715
    
    
    
    25,753
    
    
    
    101,235
    
    
    
    58,250Provision for income taxes
    
    
    10,114
    
    
    
    10,043
    
    
    
    33,986
    
    
    
    22,717Income before cumulative effect of a change in
accounting principle
    
    
    26,601
    
    
    
    15,710
    
    
    
    67,249
    
    
    
    35,533Cumulative effect of a change in accounting principle,
net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (42,959
    )Net income (loss)
    
    $
    26,601
    
    
    $
    15,710
    
    
    $
    67,249
    
    
    $
    (7,426
    )Basic earnings (loss) per common share:Income before cumulative effect of a change in
accounting principle
    
    $
    0.23
    
    
    $
    0.14
    
    
    $
    0.59
    
    
    $
    0.32Cumulative effect of a change in accounting
principle, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.39
    )Net income (loss)
    
    $
    0.23
    
    
    $
    0.14
    
    
    $
    0.59
    
    
    $
    (0.07
    )Weighted average common shares outstanding
    
    
    115,241
    
    
    
    110,755
    
    
    
    114,617
    
    
    
    109,876Diluted earnings (loss) per common share:Income before cumulative effect of a change in
accounting principle
    
    $
    0.22
    
    
    $
    0.14
    
    
    $
    0.56
    
    
    $
    0.31Cumulative effect of a change in accounting
principle, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.37
    )Net income (loss)
    
    $
    0.22
    
    
    $
    0.14
    
    
    $
    0.56
    
    
    $
    (0.06
    )Weighted average diluted common shares outstanding
    
    
    119,855
    
    
    
    115,205
    
    
    
    119,666
    
    
    
    114,662
 The accompanying notes are an integral part of these financial statements. Page 2




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES 
 
   Nine months ended September 30,2004
    
    2003Cash flows from operating activities:Net income (loss)
    
    $
    67,249
    
    
    $
    (7,426
    )Adjustments to reconcile net income (loss) to net cash provided by
operating activities:Depreciation and amortization
    
    
    41,445
    
    
    
    26,351Cumulative effect of a change in accounting principle
    
    
    
    
    
    
    42,959Impairment of assets relating to exiting a contract
    
    
    
    
    
    
    20,743Change in deferred taxes
    
    
    (7,478
    )
    
    
    4,226Equity in earnings of unconsolidated affiliates
    
    
    
    
    
    
    (4,722
    )Other non-cash items
    
    
    1,819
    
    
    
    (6,328
    )Changes in assets and liabilities (net of effects from acquisitions
of businesses):Accounts receivable, net
    
    
    (27,066
    )
    
    
    7,194Prepaid expenses
    
    
    (5,430
    )
    
    
    (8,394
    )Long-term accrued revenue
    
    
    1,883
    
    
    
    (6,085
    )Accounts payable and accrued liabilities
    
    
    (3,626
    )
    
    
    (7,642
    )Accrued compensation
    
    
    14,128
    
    
    
    6,192Income taxes
    
    
    23,785
    
    
    
    20,338Other current and non-current assets
    
    
    (37,971
    )
    
    
    (12,130
    )Other current and non-current liabilities
    
    
    15,264
    
    
    
    2,039Net cash provided by operating activities
    
    
    84,002
    
    
    
    77,315Cash flows from investing activities:Purchases of property, equipment and purchased software
    
    
    (22,260
    )
    
    
    (22,818
    )Acquisitions of businesses, net of cash acquired of
$0 and $2,930, respectively
    
    
    (8,850
    )
    
    
    (88,695
    )Net proceeds from the sale of short-term investments
    
    
    37,725
    
    
    
    Other
    
    
    (19
    )
    
    
    805Net cash provided by (used in) investing activities
    
    
    6,596
    
    
    
    (110,708
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    15,299
    
    
    
    7,165Other
    
    
    345
    
    
    
    (717
    )Net cash provided by financing activities
    
    
    15,644
    
    
    
    6,448Effect of exchange rate changes on cash and cash equivalents
    
    
    187
    
    
    
    6,979Net increase (decrease) in cash and cash equivalents
    
    
    106,429
    
    
    
    (19,966
    )Cash and cash equivalents at beginning of period
    
    
    123,770
    
    
    
    212,861Cash and cash equivalents at end of period
    
    $
    230,199
    
    
    $
    192,895
 The accompanying notes are an integral part of these financial statements. Page 3




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) 
 NOTE 1. GENERAL The accompanying unaudited interim condensed consolidated financial statements
have been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission. The interim condensed consolidated
financial statements include the consolidated accounts of Perot Systems
Corporation and its majority-owned subsidiaries with all significant
intercompany transactions eliminated. In our opinion, all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
statement of the financial position, results of operations and cash flows for
the interim periods presented have been made. Certain information and footnote
disclosures normally included in complete financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such SEC rules and regulations. Therefore, these financial
statements should be read in conjunction with the audited financial statements
for the year ended December 31, 2003, in our Annual Report on Form 10-K/A filed
with the SEC on August 3, 2004. Operating results for the three and nine month
periods ended September 30, 2004, are not necessarily indicative of the results
for the year ending December 31, 2004. Certain of the 2003 amounts in the accompanying financial statements have been
reclassified to conform to the current presentation. Stock-Based Compensation As permitted by Statement of Financial Accounting Standard No. 123, Accounting
for Stock-Based Compensation, and FAS 148, Accounting for Stock-Based
Compensation Transition and Disclosure, we have elected to follow Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees,
and related interpretations in accounting for our employee stock options. Under
APB 25, compensation expense is recorded when the exercise price of employee
stock options is less than the fair value of the underlying stock on the date
of grant. We have implemented the disclosure-only provisions of FAS 123 and FAS
148. Had we elected to adopt the expense recognition provisions of FAS 123, the
impact on net income (loss) and earnings (loss) per common share would have
been as follows: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)As reported
    
    $
    26,601
    
    
    $
    15,710
    
    
    $
    67,249
    
    
    $
    (7,426
    )Add: Stock-based compensation expense
included in reported net income (loss),
net of related tax effects
    
    
    683
    
    
    
    33
    
    
    
    943
    
    
    
    119Less: Stock-based compensation expense
determined under fair value based
methods for all awards, net of related
tax effects
    
    
    (6,433
    )
    
    
    (4,246
    )
    
    
    (16,869
    )
    
    
    (12,851
    )Pro forma
    
    $
    20,851
    
    
    $
    11,497
    
    
    $
    51,323
    
    
    $
    (20,158
    )Basic earnings (loss) per common shareAs reported
    
    $
    0.23
    
    
    $
    0.14
    
    
    $
    0.59
    
    
    $
    (0.07
    )Pro forma
    
    $
    0.18
    
    
    $
    0.10
    
    
    $
    0.45
    
    
    $
    (0.18
    )Diluted
earnings (loss) per common shareAs reported
    
    $
    0.22
    
    
    $
    0.14
    
    
    $
    0.56
    
    
    $
    (0.06
    )Pro forma
    
    $
    0.18
    
    
    $
    0.10
    
    
    $
    0.45
    
    
    $
    (0.18
    )
 Page 4




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) We utilize the Black-Scholes option pricing model to calculate our pro forma
stock-based compensation expense, and the assumptions used for each period are
as follows: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Weighted average risk free interest rates
    
    
    2.80
    %
    
    
    2.32
    %
    
    
    2.51
    %
    
    
    2.24
    %Weighted average life (in years)
    
    
    3.2
    
    
    
    3.5
    
    
    
    3.5
    
    
    
    3.6Volatility
    
    
    43
    %
    
    
    54
    %
    
    
    47
    %
    
    
    55
    %Expected dividend yield
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Weighted average grant-date fair value per
share of options granted
    
    $
    4.66
    
    
    $
    4.59
    
    
    $
    5.04
    
    
    $
    4.36
 With the exception of grants with cliff vesting and acceleration features, the
expected life of each grant was generally estimated to be a period equal to one
half of the vesting period, plus one year, for all periods presented. The
expected life for cliff vesting grants was equal to the vesting period, and the
expected life for grants with acceleration features was estimated to be equal
to the midpoint of the vesting period. NOTE 2. ACQUISITIONS Perot Systems TSI B.V. In 1996, we entered into a joint venture with HCL Technologies whereby we each
owned 50% of HCL Perot Systems B.V. (HPS), an information technology services
company based in India. On December 19, 2003, we acquired HCL Technologies
shares in HPS, and changed the name of HPS to Perot Systems TSI B.V. (TSI).
This transaction was accounted for as a step acquisition under the purchase
method of accounting. TSI is an IT services firm specializing in business
transformation and application outsourcing. TSI currently serves customers in
the United Kingdom, Singapore, Switzerland, Luxembourg, Germany, India,
Thailand, Malaysia, Japan, Australia and the United States. As a result of the
acquisition, we expanded the geographical areas in which we provide services
and broadened our customer base in our application development service
offering. Because of the late December 2003 closing of this acquisition, the
post-acquisition results of operations of TSI were not material to our
consolidated results of operations for 2003. Therefore, to simplify the process
of consolidating TSI, we continued to account for TSIs results of operations
using the equity method of accounting through December 31, 2003. The balance of
our investment in TSI immediately prior to our consolidation of TSI on December
31, 2003, was $29,495. We consolidated the assets and liabilities of TSI as of
December 31, 2003. Accordingly, the TSI assets acquired and liabilities assumed
are included in our consolidated balance sheets at December 31, 2003. The consideration paid for
the equity interests in TSI held by HCL Technologies and certain
minority interest holders was $98,834 in
cash (including acquisition costs and net of $12,667 of cash
acquired) and $4,931 relating to the fair
value of stock options to purchase shares of our Class A Common Stock that were granted to TSI associates in exchange for TSI
stock options. In the third quarter of 2004, we granted stock options to
purchase approximately 500 shares of our common stock at exercise prices below
fair value in exchange for the outstanding stock options of TSI, which resulted
in an increase in goodwill of $4,931. During 2004 we completed the appraisals of the acquired tangible and intangible
assets, which resulted in an increase to the value allocated to land of $3,984,
the recording of acquired intangibles of $7,650 and a reduction to goodwill of
$11,634. However, the allocation of TSI purchase consideration has not been
completed primarily due to the pending purchase of equity held by minority
shareholders of TSI, which represents approximately 1% of the outstanding
shares of TSI. We expect to complete the purchase price allocation in the
fourth quarter of 2004. The estimated excess purchase price over net assets
acquired of Page 5




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) $67,018 was recorded as goodwill on the condensed consolidated balance sheets,
was assigned to the Consulting segment and is not deductible for tax purposes. The following table summarizes the values assigned to the TSI assets acquired
and liabilities assumed as of December 31, 2003, as adjusted during 2004,
primarily for the changes discussed above. Current assets
    
    $
    84,282Property, equipment and purchased software, net
    
    
    25,699Goodwill (estimated)
    
    
    67,018Identifiable intangible assets
    
    
    7,650Other non-current assets
    
    
    2,069186,718Current liabilities
    
    
    (37,625
    )Other non-current liabilities
    
    
    (3,166
    )Reversal of our investment balance
    
    
    (29,495
    )Purchase consideration
    
    $
    116,432
 Soza & Company, Ltd. On February 20, 2003, we acquired all of the outstanding shares of Soza &
Company, Ltd., and the purchase agreement provided for additional payments to
be made in the future if certain financial targets were achieved. In the first
quarter of 2004, we determined that Soza had achieved certain financial targets
for 2003. As a result of achieving these targets and in accordance with the
purchase agreement, we made additional payments of $6,318 in cash and $8,580 in
641 shares of our Class A Common Stock that resulted in us recording $14,898 of
additional goodwill to the Government Services segment. This goodwill is not
deductible for tax purposes. In addition, during the first quarter of 2004 we
increased the values of certain tax assets that we had purchased in the Soza
acquisition and reduced the amount of purchase price allocated to goodwill by
$3,508. ADI Technology Corporation On July 1, 2002, we acquired all of the outstanding shares of ADI Technology
Corporation, and the purchase agreement provided for additional payments to be
made in the future if certain financial targets were achieved. In the first
quarter of 2004, we determined that ADI had achieved certain financial targets
for 2003. As a result of achieving these targets and in accordance with the
purchase agreement, we made additional payments of $2,532 in cash and $2,325 in
175 shares of our Class A Common Stock that resulted in us recording $4,857 as
additional goodwill. This goodwill was assigned to the Government Services
segment and is not deductible for tax purposes. Page 6




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) NOTE 3. GOODWILL AND OTHER INTANGIBLE ASSETS The changes in the carrying amount of goodwill for the nine months ended
September 30, 2004, by reporting segment are as follows: GovernmentIT Solutions
    
    Services
    
    Consulting
    
    TotalBalance as of December 31, 2003
    
    $
    122,817
    
    
    $
    81,029
    
    
    $
    143,730
    
    
    $
    347,576Additional goodwill for ADI
acquisition
    
    
    
    
    
    
    4,857
    
    
    
    
    
    
    
    4,857Additional goodwill for Soza
acquisition
    
    
    
    
    
    
    11,390
    
    
    
    
    
    
    
    11,390TSI purchase price allocation
adjustment
    
    
    
    
    
    
    
    
    
    
    (5,341
    )
    
    
    (5,341
    )Other
    
    
    854
    
    
    
    
    
    
    
    
    
    
    
    854Balance as of September 30, 2004
    
    $
    123,671
    
    
    $
    97,276
    
    
    $
    138,389
    
    
    $
    359,336
 The adjustment to the TSI purchase price allocation of $5,341 relates primarily
to the recording of identifiable intangible assets upon completion of the
related intangible asset appraisals. Identifiable intangible assets as of September 30, 2004, are recorded in other
non-current assets in the condensed consolidated balance sheets and are
composed of: Gross
    
    
    
    
    
    NetCarrying
    
    Accumulated
    
    BookValue
    
    Amortization
    
    ValueService marks
    
    $
    5,761
    
    
    $
    (3,414
    )
    
    $
    2,347Customer based assets
    
    
    22,599
    
    
    
    (9,154
    )
    
    
    13,445Other intangible assets
    
    
    4,855
    
    
    
    (2,358
    )
    
    
    2,497Balance at September 30, 2004
    
    $
    33,215
    
    
    $
    (14,926
    )
    
    $
    18,289
 Total amortization expense for identifiable intangible assets was $2,508 and
$7,521 for the three and nine months ended September 30, 2004, and $1,213 and
$2,796 for the three and nine months ended September 30, 2003. Amortization
expense is estimated at $9,942, $5,190, $3,995, $3,170, $2,233 and $486 for the
years ended December 31, 2004 through 2009, respectively. Identifiable
intangible assets are amortized on a straight-line basis over their estimated
useful lives, ranging from 1 to 15 years. The weighted average useful life is
approximately five years. NOTE 4. COMPREHENSIVE INCOME (LOSS) Total comprehensive income (loss), net of tax, was as follows: Three months
    
    Nine monthsended September 30,
    
    ended September 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    26,601
    
    
    $
    15,710
    
    
    $
    67,249
    
    
    $
    (7,426
    )Foreign currency translation adjustments
    
    
    (1,323
    )
    
    
    736
    
    
    
    2,088
    
    
    
    3,295Other
    
    
    107
    
    
    
    (680
    )
    
    
    357
    
    
    
    (10
    )Total comprehensive income (loss)
    
    $
    25,385
    
    
    $
    15,766
    
    
    $
    69,694
    
    
    $
    (4,141
    )
 Page 7




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) NOTE 5. STOCKHOLDERS EQUITY The components of Other stockholders equity were as follows: September 30, 2004
    
    December 31, 2003Deferred compensation
    
    $
    (4,170
    )
    
    $
    (3,814
    )Other
    
    
    (643
    )
    
    
    (360
    )Total other stockholders equity
    
    $
    (4,813
    )
    
    $
    (4,174
    )
 At September 30, 2004, there were 112,546 shares of our Class A Common Stock
outstanding and 3,275 shares of our Class B Common Stock outstanding. At
December 31, 2003, there were 109,262 shares of our Class A Common Stock
outstanding and 3,042 shares of our Class B Common Stock outstanding. The
increase in the number of Class A Common Stock outstanding is
due primarily to the
exercise of stock options and the issuance of shares to participants in the
Employee Stock Purchase Plan, which increased additional paid-in capital by
$23,052, including the related tax benefit. Additional paid-in capital also
increased by $17,757 due to issuances of shares and options to purchase shares
of our Class A Common Stock related to certain acquisitions. NOTE 6. INCOME TAXES Our effective tax rate for the third quarter of 2004 was 27.5% and our
effective tax rate for the nine months ended September 30, 2004 was 33.6%. Our
effective tax rate for the third quarter of 2003 was 39.0% and our effective
tax rate for income before cumulative effect of a change in accounting
principle for the nine months ended September 30, 2003 was 39.0%. The tax rate
for the three and nine months ended September 30, 2004 was lower than the rate
for the three and nine months ended September 30, 2003 due to the impact of our
foreign operations, including TSI, which has tax holidays in certain Asian
jurisdictions exempting specific types of income from taxation, and a reduction
in income tax expense of $3,167 relating to the resolution of various
outstanding tax issues from prior years. NOTE 7. SEGMENT DATA We offer our services under three primary lines of business, which are also
reportable segments. These lines of business are IT Solutions, Government
Services and Consulting. IT Solutions, our largest line of business, provides
services to our customers primarily under long-term contracts in strategic
relationships. These services include technology and business process services,
as well as industry domain-based, short-term project and consulting services.
The Government Services segment provides consulting and technology-based
business process solutions for the Department of Defense, Department of
Homeland Security, and other governmental agencies. The Consulting segment
provides our customers high-value and repeatable services related to business
and technical expertise and the design and implementation of business and
software solutions, primarily under short-term contracts related to specific
projects. Other includes our remaining operating areas and corporate
activities, income and expenses that are not related to the operations of the
other reportable segments, as well as the elimination of approximately $8,280
and $20,247 of intersegment revenue and cost of revenue for the three and nine
months ended September 30, 2004, respectively, related to the provision of
services by TSI (in the Consulting segment) to the other segments (for 2004
only). The reporting segments follow the same accounting policies that we use for our
consolidated financial statements. Segment performance is evaluated based on
income (loss) before taxes, exclusive of income and expenses that are included
in the Other category. All corporate and centrally incurred costs are
allocated to the segments based principally on expenses, employees, square
footage, or usage. Page 8




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) The following is a summary of certain financial information by reportable
segment: IT
    
    GovernmentSolutions
    
    Services
    
    Consulting
    
    Other
    
    TotalFor the three months ended September 30, 2004:Revenue
    
    $
    340,902
    
    
    $
    67,829
    
    
    $
    53,839
    
    
    $
    (8,280
    )
    
    $
    454,290Income before taxes
    
    
    26,177
    
    
    
    3,637
    
    
    
    6,055
    
    
    
    846
    
    
    
    36,715For the three months ended September 30, 2003:Revenue
    
    $
    305,590
    
    
    $
    54,185
    
    
    $
    11,545
    
    
    $
    10
    
    
    $
    371,330Income before taxes
    
    
    16,843
    
    
    
    2,610
    
    
    
    423
    
    
    
    5,877
    
    
    
    25,753For the nine months ended September 30, 2004:Revenue
    
    $
    979,420
    
    
    $
    201,000
    
    
    $
    147,715
    
    
    $
    (20,247
    )
    
    $
    1,307,888Income before taxes
    
    
    71,576
    
    
    
    10,841
    
    
    
    17,501
    
    
    
    1,317
    
    
    
    101,235For the nine months ended September 30, 2003:Revenue
    
    $
    885,360
    
    
    $
    147,571
    
    
    $
    34,662
    
    
    $
    139
    
    
    $
    1,067,732Income before taxes
    
    
    35,627
    
    
    
    9,676
    
    
    
    300
    
    
    
    12,647
    
    
    
    58,250
 Prior to the first quarter of
2004, our Technical Resource Connection delivery unit was
included in our Consulting segment. During the first quarter of 2004, we
restructured this group which is now included in the IT Solutions segment. All
prior period amounts have been adjusted to reflect this change. During the first nine months of 2003, we recorded $17,676 of expense in direct
cost of services associated with exiting an under-performing contract, which is
included in the IT Solutions segment. In addition, we revised our estimates to
complete our previous years streamlining efforts, resulting in a reduction in
selling, general and administrative expenses of $6,272, which is included in
the Other category. NOTE 8. EARNINGS PER SHARE The following chart is a reconciliation of the numerators and the denominators
of the basic and diluted per share computations for income before the
cumulative effect of a change in accounting principle. For the three months ended September 30,2004
    
    2003Basic Earnings per Common ShareNet Income
    
    $
    26,601
    
    
    $
    15,710Weighted average common shares outstanding
    
    
    115,241
    
    
    
    110,755Basic earnings per common share
    
    $
    0.23
    
    
    $
    0.14Diluted Earnings per Common ShareNet Income
    
    $
    26,601
    
    
    $
    15,710Weighted average common shares outstanding
    
    
    115,241
    
    
    
    110,755Incremental shares assuming dilution
    
    
    4,614
    
    
    
    4,450Weighted average diluted common shares outstanding
    
    
    119,855
    
    
    
    115,205Diluted earnings per common share
    
    $
    0.22
    
    
    $
    0.14
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) For the nine months ended September 30,2004
    
    2003Basic Earnings per Common ShareIncome before cumulative effect of a change in accounting principle
    
    $
    67,249
    
    
    $
    35,533Weighted average common shares outstanding
    
    
    114,617
    
    
    
    109,876Basic earnings per common share before cumulative effect of a
change in accounting principle
    
    $
    0.59
    
    
    $
    0.32Diluted Earnings per Common ShareIncome before cumulative effect of a change in accounting principle
    
    $
    67,249
    
    
    $
    35,533Weighted average common shares outstanding
    
    
    114,617
    
    
    
    109,876Incremental shares assuming dilution
    
    
    5,049
    
    
    
    4,786Weighted average diluted common shares outstanding
    
    
    119,666
    
    
    
    114,662Diluted earnings per common share before cumulative effect of a
change in accounting principle
    
    $
    0.56
    
    
    $
    0.31
 For the three and nine months ended September 30, 2004, options to purchase
13,450 and 13,405 shares, respectively, of our common stock were excluded from
the calculation of diluted earnings per common share because the impact was
antidilutive given that the exercise prices for these options were higher than
our average stock price for these periods. For the three and nine months ended
September 30, 2003, options to purchase 21,508 and 21,546 shares, respectively,
of our common stock were excluded for the same reason as discussed above. NOTE 9. CURRENT PORTION OF LONG-TERM DEBT In June 2000, we entered into an operating lease contract with a variable
interest entity for the use of land and office buildings in Plano, Texas,
including a data center facility. As part of our adoption of Financial
Accounting Standards Board Interpretation No. 46, Consolidated Financial
Statements, we began consolidating this entity beginning on December 31, 2003.
Upon consolidation, we recorded the long-term debt between the variable
interest entity and the financial institutions (the lenders) of $75,498 as our
long-term debt. The agreement matures in June 2005 with one optional two year
extension. We are currently pursuing plans to refinance the obligation and
consequently do not expect to exercise our option to extend the agreement. As a
result, the amount outstanding of $75,498 is included in the current portion of
long-term debt on our condensed consolidated balance sheets. NOTE 10. CREDIT FACILITY On January 20, 2004, we entered into a revolving credit facility with a
syndicate of banks that allows us to borrow up to $100,000. Borrowings under
the credit facility will be either through revolving loans or letters of credit
obligations. The credit facility is guaranteed by certain of our domestic
subsidiaries. In addition, we have pledged the stock of one of our non-domestic
subsidiaries as security on the facility. Interest on borrowings varies with
usage and begins at an alternate base rate, as defined in the credit facility
agreement, or the LIBOR rate plus an applicable spread based upon our
debt/EBITDA ratio applicable on such date. We are also required to pay a
facility fee based upon the unused credit commitment and certain other fees
related to letter of credit issuance. The credit facility matures on January
19, 2007, and requires certain financial covenants, including a debt/EBITDA
ratio, a minimum interest coverage ratio, a minimum capitalization ratio and a
minimum current ratio, each as defined in the credit facility agreement. As of
September 30, 2004, there have been no borrowings under this credit facility. Page 10




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) NOTE 11. OUTSOURCING AGREEMENT WITH UBS UBS AG is our largest customer. During 2003, our UBS relationship generated
$242,027, or 16.6%, of our revenue. Our outsourcing agreement with
UBS will end January 1,
2007. This agreement entitles us to recover our costs plus a fixed fee, with a
bonus or penalty that can cause this annual fee to vary up and down by as much
as 13%, depending on our level of performance as determined by UBS, which is
the variable component of our annual fee. We also provide additional project
services to UBS. As a result, the revenue and gross profit that we derive from
our UBS relationship depends on our performance and on the level of services we
provide to UBS. The amount of gross profit that we have earned from UBS has
ranged from approximately $44,200 to $50,200 per year during the past three
calendar years. On September 16, 2004, we entered into the EPI Transition Agreement with UBS,
which includes the following significant provisions:  
    
    Specifies the timing of and terms for the transition of management
responsibility and employees to UBS in connection with the end of our
outsourcing contract.
    
    Eliminates the exclusivity arrangement in the outsourcing agreement
and establishes minimum revenue requirements.
    
    Modifies the variable component of the annual fee by eliminating the
potential bonus and reducing the potential penalty from 13% to 3.5%
for 2004 and removes the variable component of the annual fee for 2005
and 2006. We will continue to be compensated for the services we provide under the
outsourcing agreement using a cost plus fixed fee arrangement. In addition, we
entered into a new framework master services agreement under which we can
provide future services to UBS as part of their preferred vendor
program. NOTE 12. COMMITMENTS AND CONTINGENCIES Litigation We are involved in the following legal proceedings. IPO Allocation Securities Litigation In July and August 2001, we, as well as some of our current and former officers
and the investment banks that underwrote our initial public offering, were
named as defendants in two purported class action lawsuits. These lawsuits,
Seth Abrams v. Perot Systems Corp. et al. and Adrian Chin v. Perot Systems,
Inc. et al., were filed in the United States District Court for the Southern
District of New York. The suits allege violations of Rule 10b-5, promulgated
under the Securities Exchange Act of 1934, and Sections 11, 12(a)(2) and 15 of
the Securities Act of 1933. Approximately 300 issuers and 40 investment banks
have been sued in similar cases. The suits against the issuers and
underwriters have been consolidated for pretrial purposes in the IPO Allocation
Securities Litigation. The lawsuit involving us focuses on alleged improper
practices by the investment banks in connection with our initial public
offering in February 1999. The plaintiffs allege that the investment banks, in
exchange for allocating public offering shares to their customers, received
undisclosed commissions from their customers on the purchase of securities and
required their customers to purchase additional shares in aftermarket trading.
The lawsuit also alleges that we should have disclosed in our public offering
prospectus the alleged practices of the investment banks, whether or not we
were aware that the practices were occurring. The plaintiffs are seeking
unspecified damages, statutory compensation and costs and expenses of the
litigation. Page 11




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) During 2002, the current and former officers and directors of Perot Systems
Corporation that were individually named in the lawsuits referred to above were
dismissed from the cases. In exchange for the dismissal, the individual
defendants entered agreements with the plaintiffs that toll the running of the
statute of limitations and permit the plaintiffs to refile claims against them
in the future. In February 2003, in response to the defendants motion to
dismiss, the court dismissed the plaintiffs Rule 10b-5 claims against us, but
did not dismiss the remaining claims. We have accepted a settlement proposal presented to all issuer defendants.
Pursuant to the proposed settlement, plaintiffs would dismiss and release all
claims against us and our current and former officers and directors, in
exchange for an assurance by the insurance companies collectively responsible
for insuring the issuers in all of the IPO cases that the plaintiffs will
achieve a minimum recovery (including amounts recovered from the underwriters),
and for the assignment or surrender of certain claims we may have against the
underwriters. We would not be required to make any cash payment with respect
to the settlement. The proposed settlement would also require court approval,
which cannot be assured. The underwriters are opposing approval of the
proposed settlement and have requested that, if the settlement is approved,
they receive a corresponding reduction in any judgment amounts that they may be
ordered to pay if they are found liable in the actions. Litigation Relating to the California Energy Market In June 2002, we were named as a defendant in a purported class action lawsuit
that alleges that we conspired with energy traders to manipulate the California
energy market. This lawsuit, Art Madrid v. Perot Systems Corporation et al.,
was filed in the Superior Court of California, County of San Diego. The case
is currently pending in the Superior Court for the County of Sacramento. The
plaintiffs are seeking unspecified damages, treble damages, restitution,
punitive damages, interest, costs, attorneys fees and declaratory relief. In
September 2003, we filed a demurrer to the complaint and an alternative motion
to strike all claims for monetary relief. In January 2004, the court granted
our demurrer and did not grant the plaintiffs leave to amend their complaint.
The plaintiffs, however, have appealed. In June, July and August 2002, Perot Systems, Ross Perot and Ross Perot, Jr.,
were named as defendants in eight purported class action lawsuits that allege
violations of Rule 10b-5, and, in some of the cases, common law fraud. These
suits allege that our filings with the Securities and Exchange Commission
contained material misstatements or omissions of material facts with respect to
our activities related to the California energy market. All of these eight
cases have been consolidated in the Northern District of Texas, Dallas Division
in the case of Vincent Milano v. Perot Systems Corporation. The plaintiffs in
this case filed a consolidated amended complaint in July 2003. The plaintiffs
are seeking unspecified monetary damages, interest, attorneys fees and costs.
In October 2003, we moved to dismiss the amended complaint with prejudice. In
October 2004, the court dismissed the suit without prejudice. The plaintiffs
have the right to amend their complaint. Other In addition to the matters described above, we have been, and from time to time
are, named as a defendant in various legal proceedings in the normal course of
business, including arbitrations, class actions and other litigation involving
commercial and employment disputes. Certain of these proceedings include
claims for substantial compensatory or punitive damages or claims for
indeterminate amounts of damages. In view of the inherent difficulty of predicting the outcome of such matters,
particularly in cases in which claimants seek substantial or indeterminate
damages, we cannot predict with certainty the eventual loss or range of loss
related to such matters. We are contesting liability and/or the amount of
damages, in each pending matter and believe, based on current knowledge and
after consultation with counsel, that the outcome of these matters will not
have a material adverse effect on our consolidated financial condition, Page 12




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) although the outcome could be material to our operating results for a
particular future period, depending on, among other things, the level of our
income for such period. We have purchased, and expect to continue to purchase, insurance coverage that
we believe is consistent with coverage maintained by others in the industry.
This coverage is expected to limit our financial exposure to claims covered by
these policies in many cases. Contract-related Contingency During 2003 we exited an under-performing contract. As a result of the exiting
of this contract, we determined that certain contract-related assets were
impaired and additional expenses would be incurred related to the exiting of
this contract, resulting in a loss of $17,676 that was recorded in the second
quarter of 2003 in direct cost of services. This estimated loss represents our
current estimate of the loss related to exiting this contract and is in
addition to the loss of approximately $19,500 that we recorded in the first
quarter of 2003 in our cumulative effect of a change in accounting principle
upon adoption of EITF 00-21. We have filed a claim in arbitration to recover
amounts we believe are due under this contract, and the other party filed
counterclaims. Therefore, the amount of actual loss with respect to exiting
this contract may vary from our current estimates. Purchase Commitment We have an agreement with a telecommunication service provider to purchase
services from, or sell services on behalf of, this provider having a gross
value of $19,500 over a four-year commitment period. We entered into
arbitration with this vendor in 2003 and had recorded a liability for our
estimate of the unfulfilled minimum purchase commitment of $5,550 at December
31, 2003. The arbitration concluded in the first quarter of 2004, and based on
the outcome, we recorded an additional liability of $3,273 through a charge to
direct cost of services. The total liability recorded through the first
quarter of 2004 of $8,823 relates to the unfulfilled minimum purchase
commitment for the first three years of the commitment period, which ended on
March 31, 2004. We currently expect to fulfill the minimum purchase commitment
for the final year of the commitment period that ends on March 31, 2005. Guarantees and Indemnifications We have applied the disclosure provisions of FASB Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees and Indebtedness of Others, to our agreements that contain
guarantee or indemnification clauses. FIN 45 requires us to disclose certain
types of guarantee and indemnification arrangements, even if the likelihood of
our being required to perform under these arrangements is remote. The following
is a description of arrangements in which we are a guarantor, as defined by FIN
45. We are a party to a variety of agreements under which we may be obligated to
indemnify another party. Typically, these obligations arise in the context of
contracts entered in the normal course of business under which we agree to hold
the other party harmless against losses arising from certain matters, which may
include death or bodily injury, loss of or damage to tangible personal
property, improper disclosures of confidential information, infringement or
misappropriation of copyrights, patent rights, trade secrets or other
intellectual property rights, breaches of third party contract rights, and
violations of certain laws applicable to our services, products or operations.
The indemnity obligation in these arrangements is customarily conditioned on
the other party making an adverse claim pursuant to the procedures specified in
the particular contract, which procedures typically allow us to challenge the
other partys claims. The term of these indemnification provisions typically
survives in perpetuity after the applicable contract terminates. In some
instances, we may have recourse against third parties for certain payments made
by us. It is not possible to predict the maximum potential amount of future
payments under these or similar agreements, due to the conditional nature of
our obligations and the unique facts and circumstances involved in each Page 13




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(SHARES AND DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED) particular agreement. However, we have purchased and expect to continue to
purchase a variety of liability insurance policies, which are expected, in most
cases, to limit our financial exposure to claims covered by such policies
(other than claims relating to the infringement or misappropriation of
copyrights, patent rights, trade secrets or other intellectual property). In
addition, we have not historically incurred material costs individually or in
the aggregate to defend lawsuits or settle claims related to these
indemnification provisions. As a result, we believe the likelihood of a
material liability under these arrangements is remote. Accordingly, we have no
significant liabilities recorded for these agreements as of September 30, 2004. We include warranty provisions in substantially all of our customer contracts
in the ordinary course of business. These provisions generally provide that our
services will be performed in an appropriate and legal manner and that our
products and other deliverables will conform in all material respects to
specifications agreed between our customer and us. Our obligations under these
agreements may be limited in terms of time or amount or both. In addition, we
have purchased and expect to continue to purchase errors and omissions
insurance policies, which are expected, in most cases, to offset a portion of
our financial exposure to claims covered by such policies. Because our
obligations are conditional in nature and depend on the unique facts and
circumstances involved in each particular matter, we record liabilities for
these arrangements only on a case by case basis when management determines that
it is probable that a liability has been incurred. As of September 30, 2004, we
have no significant liabilities recorded for warranty claims. Page 14




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 
 ITEM 2: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with our
Condensed Consolidated Financial Statements and related notes included
elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on
Form 10-K/A for the fiscal year ended December 31, 2003, and with the
information under the heading Managements Discussion and Analysis of
Financial Condition and Results of Operations in our Annual Report on Form
10-K/A for the fiscal year ended December 31, 2003. Overview of Our Financial Results for the Third Quarter of 2004 Our financial results are affected by a number of factors, including broad
economic conditions, the amount and type of technology spending by our
customers, and the business strategies and financial condition of our customers
and the industries we serve, which could result in increases or decreases in
the amount of services that we provide to our customers and the pricing of such
services. Our ability to identify and effectively respond to these factors is
important to our future financial and growth position. We evaluate our consolidated performance on the basis of numerous performance
indicators. The four key performance indicators we use are revenue growth,
earnings growth, free cash flow for the period, and the value of contracts
signed during the last twelve months. We compare these key performance
indicators to both annual target amounts established by management and to our
performance for prior periods. We establish the targets for these key
performance indicators primarily on an annual basis, but we may revise them
during the year. We assess our performance using these key indicators on a
quarterly and annual basis. Below is a summary of our financial results for the third quarter of 2004 as
compared to the third quarter of 2003: Three Months Ended September 30(In millions, except per share data)2004
    
    2003
    
    % ChangeRevenue
    
    $
    454.3
    
    
    $
    371.3
    
    
    
    22.4
    %Direct cost of services
    
    
    356.3
    
    
    
    301.4
    
    
    
    18.2
    %Gross profit
    
    
    98.0
    
    
    
    69.9
    
    
    
    40.2
    %Selling, general and administrative expenses
    
    
    62.0
    
    
    
    46.9
    
    
    
    32.2
    %Operating income
    
    
    36.0
    
    
    
    23.0
    
    
    
    56.5
    %Interest income, net
    
    
    0.1
    
    
    
    0.5
    
    
    
    (80.0
    %)Other income (expense), net
    
    
    0.6
    
    
    
    2.3
    
    
    
    (73.9
    %)Income before taxes
    
    
    36.7
    
    
    
    25.8
    
    
    
    42.2
    %Provision for income taxes
    
    
    10.1
    
    
    
    10.1
    
    
    
    0.0
    %Net income
    
    $
    26.6
    
    
    $
    15.7
    
    
    
    69.4
    %Diluted earnings per common share
    
    $
    0.22
    
    
    $
    0.14
    
    
    
    57.1
    %Weighted average diluted shares outstanding
    
    
    119.9
    
    
    
    115.2
    
    
    
    4.1
    %
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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Revenue Growth Revenue growth is a measure of the growth we generate through new sales of
services, retention of existing contracts, and discretionary services from
existing customers. For the third quarter of 2004, revenue grew by 22.4% as
compared to the third quarter of 2003. As discussed in more detail below, this
revenue growth came primarily from the following:  §
    
    Revenue from TSI, which we acquired in December 2003, as discussed
below in Acquisition of Perot Systems TSI B.V.§
    
    An increase in discretionary technology investments by our customers,
which we believe is due to an improvement in economic conditions.§
    
    Revenue from new contracts signed during the twelve-month period
following the third quarter of 2003. Earnings Growth We measure earnings growth using diluted earnings per share, which is a measure
of our effectiveness in delivering profitable growth. For the third quarter of
2004, diluted earnings per share increased 57.1% to $0.22 per share from $0.14
per share for the third quarter of 2003. As discussed in more detail below,
this increase came primarily from:  §
    
    Income from TSI, which we acquired in December 2003.§
    
    An improvement in the profitability for certain fixed- and unit-priced
outsourcing contracts. Typically, we realize less profit at the
beginning of these contractual relationships. However, as these
contracts and customer relationships mature, we are usually able to
improve profitability by implementing process and technology
improvements and by providing additional services to the customer,
which are typically discretionary in nature and tend to be more
profitable than the base outsourcing services.§
    
    Partially offsetting these increases in earnings were decreases to
earnings from three major customer contracts and an increase in
expense in 2004 for year-end bonuses to associates. We continue to see prospective customers desiring fixed and per-unit pricing
mechanisms for the billing of our outsourcing services. While these pricing
mechanisms typically impact the initial profit margins on new contracts, they
do not necessarily affect the overall expected profitability of new contracts. Free Cash Flow We calculate free cash flow on a trailing twelve month basis as net cash
provided by operating activities less purchases of property, equipment and
purchased software, as stated in our consolidated statements of cash flows. We
use free cash flow as a measure of our ability to generate cash for both our
short-term and long-term operating and business expansion needs. We use a
twelve-month period to measure our success in this area because of the
significant variations that typically occur on a quarterly basis due to the
timing of certain cash payments. Free cash flow for the twelve months ended
September 30, 2004 was $81.8 million as compared to $68.0 million for the
twelve months ended September 30, 2003. Free cash flow can be reconciled to
Net cash provided by operating activities as follows: Twelve Months Ended September 302004
    
    2003Net cash provided by operating activities
    
    $
    109.6
    
    
    $
    102.2Purchases of property, equipment and software
    
    
    (27.8
    )
    
    
    (34.2
    )Free cash flow
    
    $
    81.8
    
    
    $
    68.0
 Page 16




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS TCV of Contracts Signed The amount of Total Contract Value (commonly referred to as TCV) that we sell
during a certain twelve-month period is a measure of our success in capturing
new business in the various outsourcing and consulting markets in which we
provide services. We measure TCV as our estimate of the total expected revenue
from new contracts with new customers where the contract is expected to
generate revenue in excess of a defined amount during its contract term and the
contract term exceeds a defined length of time. If a new contract does not meet
the defined amount of revenue or length of term, it is not included in our TCV
calculation. Various factors may impact the timing of when a contract is signed, including
the complexity of the contract, competitive pressures, and customer demands.
As a result, we use a twelve-month period to measure our success in this area
because of the significant variations that typically occur in the amount of TCV
signed during each quarterly period. During the twelve-month period ending
September 30, 2004, the amount of TCV signed was $1.2 billion, which is the
same as the twelve-month period ending September 30, 2003. Additional Measurements Our three major lines of business are IT Solutions, Government Services, and
Consulting. Each of these three major lines of business has distinct economic
factors, business trends, and risks that could affect our results of
operations. As a result, in addition to the four metrics discussed above that
we use to measure our consolidated financial performance, we use similar
metrics for each of these lines of business and for certain industry groups and
operating units within these lines of business. Our Outsourcing Agreement with UBS UBS AG is our largest customer. During 2003, our UBS relationship generated
$242.0 million, or 16.6%, of our revenue. Our outsourcing agreement with UBS
will end January 1, 2007. This agreement entitles us to recover our costs plus a fixed
fee, with a bonus or penalty that can cause this annual fee to vary up and down
by as much as 13%, depending on our level of performance as determined by UBS,
which is the variable component of our annual fee. We also provide additional
project services to UBS. As a result, the revenue and gross profit that we
derive from our UBS relationship depends on our performance and on the level of
services we provide to UBS. The amount of gross profit that we have earned
from UBS has ranged from $44.2 million to $50.2 million per year during the
past three calendar years. On September 16, 2004, we entered into the EPI Transition Agreement with UBS,
which includes the following significant provisions:  §
    
    Specifies the timing of and terms for the transition of management
responsibility and employees to UBS in connection with the end of our
outsourcing contract.§
    
    Eliminates the exclusivity arrangement in the outsourcing agreement
and establishes minimum revenue requirements.§
    
    Modifies the variable component of the annual fee by eliminating the
potential bonus and reducing the potential penalty from 13% to 3.5%
for 2004 and removes the variable component of the annual fee for 2005
and 2006. We will continue to be compensated for the services we provide under the
outsourcing agreement using a cost plus fixed fee arrangement. In addition, we
entered into a new framework master services agreement under which we can
provide future services to UBS as part of their preferred vendor
program. The Transition Agreement, including the amendments to the outsourcing contract,
does not materially change our expectation of revenue and gross profit that we
will earn from UBS during the remaining term of Page 17




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS the outsourcing contract. As previously announced, we continue to expect that
we will lose a substantial majority of our revenue and profit from UBS when our
outsourcing contract with UBS ends on January 1, 2007. The impact of the
expiration of the outsourcing agreement on our profits will be based in part on
our ability to reduce our costs. We expect that the expiration of the
outsourcing agreement likely will have a disproportionately large effect on our
profitability compared to the effect on our revenues. We expect the services we
provide to UBS post 2006 will include offshore services, which are provided
outside the scope of the outsourcing contract and currently represent
approximately $30.0 million of annual revenue outside the outsourcing contract. We have identified several operating efficiencies that we believe could reduce
the negative impact on our operating income that we expect from the expiration
of the UBS outsourcing agreement. We expect to realize between $50.0 million
and $60.0 million of operating efficiencies by the end of 2007, including
efficiencies we expect on existing fixed- and unit- priced contracts of $30.0
million by the end of 2007, reducing existing selling, general and
administrative expenses by $10.0 million by the end of 2006 with approximately
$5.0 million of this reduction coming from existing amortization expense during
2005, and between $10.0 million and $20.0 million of other expense reductions
to be realized before the conclusion of 2007. We believe our ability to increase revenues will depend primarily on the
success of our units focused on selling services to Healthcare, Federal
Government and Offshore Services markets. These three areas currently comprise
76.9% of our third quarter of 2004 revenue, excluding UBS outsourcing revenue.
For the third quarter of 2004, revenue from the Healthcare and Government
markets grew by 18.2% and 25.2% year-to-year, respectively. Pro forma
year-to-year revenue growth for TSI, our offshore application development and
management unit, was 46.8% for the third quarter of 2004. Pro forma growth
looks at the underlying growth of TSI, which we acquired and consolidated
beginning on December 31, 2003. While we may not continue to grow these areas
at these rates, we believe that we will continue to experience strong growth in
these areas. In addition to this growth, we plan to continue adding to our
capabilities through acquisitions. In expanding our business, we plan to add
future SG&A at approximately 5.0% of new revenue long-term, excluding the
effect of acquisitions. Acquisition of Perot Systems TSI B.V. As discussed in Note 2 to the condensed consolidated financial statements,
Acquisitions, on December 19, 2003, we acquired HCL Technologies shares in
HPS, and changed the name of HPS to Perot Systems TSI B.V. Because of the late
December 2003 closing of this acquisition, the post-acquisition results of
operations of TSI were not material to our consolidated results of operations
for 2003. As a result, we continued to account for TSIs results of operations
using the equity method of accounting through December 31, 2003, and we
consolidated the assets and liabilities of TSI as of December 31, 2003. Change in Accounting Principle for Revenue Arrangements with Multiple
Deliverables We adopted EITF 00-21 effective January 1, 2003, for both existing and
prospective customer contracts, which resulted in an expense in the first
quarter of 2003 for the cumulative effect of a change in accounting principle
of $69.3 million ($43.0 million, net of the applicable income tax benefit), or
$0.37 per diluted share. This adjustment resulted primarily from the reversal
of unbilled revenues associated with our long-term fixed price contracts that
include construction-type services, as each such contract had been accounted
for as a single unit of accounting using the percentage-of-completion method.
This adjustment also includes approximately $19.5 million (approximately $12.1
million, net of the applicable income tax benefit), or $0.11 per diluted share,
to recognize an estimated loss on a construction-type service included in a
contract with multiple deliverables that we expected to be profitable in the
aggregate over its term and that was previously accounted for as a single unit
of accounting using the percentage-of-completion method, as discussed below
under Exiting of a Customer Contract. As a result of our adoption of EITF 00-21, we recognized revenues of
approximately $0.8 million during each of the first three quarters of 2004 that
were included in the cumulative effect of a change in accounting Page 18




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS principle, which we recorded in the first quarter of 2003. Exiting of a Customer Contract In 2001, we entered into a long-term fixed-price IT outsourcing contract with a
customer that included various non-construction services and a construction
service, which was an application development project. In 2002, we began to
expect that the actual cost to complete the application development project
would exceed the cost estimate included in the contract with the customer. The
contract provided for us to collect most of the excess of the actual cost over
the cost estimate in the contract, but we expected the project to generate a
loss because we did not expect to collect all of the excess of the actual cost
over the cost estimate in the contract. However, we did not recognize a loss
on the contract at that time. Prior to the adoption of EITF 00-21, we recorded
revenue and profit on our fixed-price contracts that included both construction
and non-construction services using the percentage-of-completion method of
accounting. Therefore, because we expected that the contract would be
profitable in the aggregate over its term, we did not recognize a loss on this
contract in 2002. As part of our adoption of EITF 00-21 in the first quarter of 2003, we were
required to separate the deliverables in the contract into multiple units of
accounting. As a result, we recognized a net estimated loss on the application
development project totaling approximately $19.5 million (approximately $12.1
million, net of the applicable income tax benefit), or $0.11 per diluted share,
which was recorded as part of the cumulative effect of a change in accounting
principle. The $19.5 million loss on the application development project is
composed of two adjustments:  §
    
    The reversal of $8.9 million of revenue and profit that was recognized
prior to January 1, 2003, to adjust to the amount that would have been
recorded if we had applied the percentage-of-completion method to this
project separately.§
    
    The recording of a future estimated loss of $10.6 million as of
January 1, 2003, which was calculated as the difference between the
estimated amount that we expected to collect from the customer and the
estimated costs to complete the application development project. In the second quarter of 2003, we were unable to reach agreement with the
customer on the timing and form of payment for the excess of the actual cost
over the cost estimate in the contract. As a result, we exited this contract
and recorded an additional $17.7 million of expense in direct cost of services
in the second quarter of 2003, which consists of the following:  §
    
    The impairment of assets related to this contract totaling $20.7
million, including the impairment of $14.7 million of long-term
accrued revenue.§
    
    The accrual of estimated costs to exit this contract of $3.8 million.§
    
    Partially offsetting the above expenses was the reversal of $6.8
million in accrued liabilities that had been recognized for future
losses that we expected to incur to complete the application
development project. We completed the services necessary to transition certain functions back to the
client during the fourth quarter of 2003. We have filed a claim in arbitration
to recover amounts we believe are due under this contract, and the other party
filed counterclaims. Therefore, the amount of actual loss with respect to
exiting this contract may vary from our current estimates. Page 19




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Comparison of the Three Months Ended September 30, 2004 and 2003 Revenue Revenue for the third quarter of 2004 increased by $83.0 million, or 22.4%, to
$454.3 million from revenue of $371.3 million for the third quarter of 2003 due
to increases in revenue from the IT Solutions, Government Services and
Consulting segments. Revenue from the IT Solutions segment increased by $35.3 million, or 11.6%, to
$340.9 million for the third quarter of 2004 from revenue of $305.6 million in
the third quarter of 2003. This net increase was primarily attributable to:  §
    
    $30.0 million net increase from existing accounts, short-term
offerings, and project work. This net increase results from expanding
our base services to existing long-term customers and from providing
additional discretionary services to these customers. The
discretionary services that we provide, which include short-term
offerings and project work, can vary from period-to-period depending
on many factors, including specific customer and industry needs and
economic conditions. The majority of this increase is related to
contracts in the healthcare industry; however, we have also
experienced increases in both the manufacturing market and the
construction and engineering market. Overall, the healthcare industry
is in a state of change. Health systems are transforming their
clinical and administrative back-office operations, payer
organizations are developing new consumer-based health models, and the
rate of medical cost inflation continues to increase. These changes
require increased system investment, which creates demand for our
services. Because of the increased complexity associated with system
changes and combined with a desire to focus on core functions, the
healthcare outsourcing market has experienced increased levels of
business. Within the manufacturing market and the construction and
engineering market, we have also experienced increased levels of
business primarily as a result of customers continuing needs to
reduce expense and to improve the efficiency of their operations.§
    
    $14.2 million increase from contracts signed during the twelve-month
period following the third quarter of 2003. This revenue comes
primarily from new contracts signed in the healthcare, manufacturing,
and construction and engineering markets, and the services that we are
providing to these new customers are primarily the same services that
we provide to the majority of our other long-term outsourcing
customers.§
    
    Partially offsetting these increases was an $8.9 million decrease in
revenue associated with three major customer contract changes. As
discussed above in Exiting of a Customer Contract, we exited an
under-performing contract during the second quarter of 2003, resulting
in a $5.5 million decrease in revenue for the third quarter of 2004 as
compared to the prior year period. Additionally, we completed two
major contract renewals that resulted in a revenue reduction of $3.4
million for the third quarter of 2004 as compared to the third quarter
of 2003, primarily relating to reductions in price. Although pricing
reductions were made on these two major contracts, the circumstances
for these reductions differ for the two contract renewals. For one of
these renewals, we were realizing higher than normal profit margins
primarily because our contract pricing included the recovery of a
significant investment that was made at the beginning of the contract.
When the customer was acquired by another company, we signed a new
long-term services agreement with a reduced scope of services, less
up-front investment, and a corresponding reduction in price. For the
second renewal, the customer agreed to enter into a long-term
arrangement for services that we were performing on a short-term
basis. Because of the long-term commitment, we have less risk on the
contract, and we therefore reduced the price. Revenue from the Government Services segment increased $13.6 million, or 25.1%,
to $67.8 million for the third quarter of 2004 from $54.2 million for the third
quarter of 2003. This increase is primarily attributable to new contracts and
existing program expansion with the Department of Homeland Security, the
Department of Defense, and civilian agencies of the federal government. For
the contracts underlying this revenue increase, we are providing program
management, administrative, professional and engineering Page 20




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS services related to both a recently awarded program by the Department of
Homeland Security and from existing programs where specific initiatives of the
government required additional resources for the third quarter of 2004 as
compared to the same period in the prior year. Our business with the federal
government may fluctuate due to annual federal funding limits and the specific
needs of the federal agencies we serve. Revenue from the Consulting segment increased 296.5% to $45.6 million for the
third quarter of 2004, net of the elimination of intersegment revenue of $8.3
million, from $11.5 million for the third quarter of 2003. This increase is
primarily attributable to the acquisition of TSI, which contributed $29.8
million of revenue, net of the elimination of intersegment revenue of $8.3
million, for the third quarter of 2004. The remaining increase results from
increased revenue from technology and business consulting services, primarily
attributable to an increased level of services related to the implementation of
packaged software applications. These services are typically viewed as
discretionary services by our customers with the level of business activity
depending on many factors including economic conditions and specific customer
needs. Revenue from UBS, our largest customer, was $72.4 million for the third quarter
of 2004, or 15.9% of revenue. This revenue is reported within the IT Solutions
and Consulting lines of business and is summarized in the following table: Three Months Ended September 302004
    
    2003
    
    ChangeUBS revenue in IT Solutions
    
    $
    63.9
    
    
    $
    58.7
    
    
    
    8.9
    %UBS revenue in Consulting
    
    
    8.5
    
    
    
    
    
    
    
    n/mTotal revenue from UBS
    
    $
    72.4
    
    
    $
    58.7
    
    
    
    23.3
    %
 The increase in revenue from UBS for the IT Solutions line of business for the
third quarter of 2004 as compared to the prior year period is due primarily to
a change in our estimate of the variable component of our annual fee following
the execution of the Transition Agreement between us and UBS. The increase in
revenue from UBS for the Consulting line of business is due to the acquisition
of TSI as discussed above. Gross Margin Gross margin, which is calculated as gross profit divided by revenue, for the
third quarter of 2004 was 21.6% of total revenue, which is higher than the
gross margin for the third quarter of 2003 of 18.8% of total revenue. This
year-to-year increase in gross margin is primarily due to the following:  §
    
    In December of 2003 we acquired TSI, which increased our gross margin
for the third quarter of 2004 by 1.5 percentage points. TSI
typically realizes higher gross margins than what we normally realize
on traditional IT outsourcing contracts because of the nature of the
services they provide, which are offshore business process outsourcing
and application management services.§
    
    An overall net increase in profitability for existing commercial
customer contracts, which is primarily due to an increase in the
amount of services we perform that are in addition to our base level
of services, changes in our estimates of the variable component of our
annual fee from UBS, and a software license fee of $1.6 million that
is not expected to recur in the fourth quarter of 2004. The increased
services are discretionary in nature, and the associated gross margins
are typically higher than those we realize on our base level of
services. As discussed above, we have seen increased demand for
discretionary investment from several customers, primarily in the
healthcare industry. Partially offsetting these increases were the three major customer contract
changes discussed above, which reduced gross margin by 0.6 percentage points,
and an increase in expense of $4.6 million for year-end bonuses for the
majority of the associates in our IT Solutions segment. We have several
separate bonus plans for various associate groups within our Government
Services and Consulting segments, and the impact on gross margin from the bonus
expense recorded under these other plans did not differ significantly in the
third quarter of 2004 as compared to the prior year period. Page 21




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Selling, General and Administrative Expenses Selling, general and administrative expenses for the third quarter of 2004
increased 32.2% to $62.0 million from $46.9 million for the third quarter of
2003. SG&A for the third quarter of 2004 was 13.6% of revenue, which is higher
than SG&A for the third quarter of 2003 of 12.6% of revenue. The increase is
primarily attributable to the acquisition of TSI, which added $6.4 million of
SG&A expense, $2.6 million of expense associated with exiting a leased
facility, and an increase of $1.5 million in expenses associated with corporate
compliance and business insurance. Other Statement of Operations Items Interest expense for the third quarter of 2004 increased by $0.5 million as
compared to the third quarter of 2003. This increase is primarily related to
the debt we recorded on our consolidated balance sheet as of December 31, 2003,
upon adoption of Financial Accounting Standards Board Interpretation No. 46,
Consolidation of Variable Interest Entities. During the third quarter of 2003, we recorded $1.7 million of income from our
previous 50% equity in the earnings of TSI, which we consolidated on December
31, 2003, following the acquisition of HCL Technologies shares in TSI. Our effective tax rate for the third quarter of 2004 was 27.5%. Our effective
tax rate for the third quarter of 2003 was 39.0%. The tax rate for the third
quarter of 2004 was lower than the rate in 2003 due to the impact of our
foreign operations, including TSI, which has tax holidays in certain Asian
jurisdictions exempting specific types of income from taxation, and a reduction
in income tax expense of $3.2 million relating to the resolution of various
outstanding tax issues from prior years. We expect our effective tax rate to
be approximately 36.7% for the fourth quarter of 2004. Comparison of the Nine Months Ended September 30, 2004 and 2003 Revenue Revenue for the nine months ended September 30, 2004, increased by $240.2
million, or 22.5%, to $1,307.9 million from revenue of $1,067.7 million for the
nine months ended September 30, 2003, due to increases in revenue from the IT
Solutions, Government Services and Consulting segments. Revenue from the IT Solutions segment increased by $94.0 million, or 10.6%, to
$979.4 million for the first nine months of 2004 from revenue of $885.4 million
in the first nine months of 2003. This net increase was primarily attributable
to:  §
    
    $74.6 million net increase from existing accounts, short-term
offerings, and project work. This net increase is a result of both
the expansion of base services to existing long-term customers and the
provision of additional discretionary services to these customers.
The discretionary services that we provide, which include short-term
offerings and project work, can vary from period-to-period depending
on many factors, including specific customer and industry needs and
economic conditions. The majority of this increase is related to
contracts in the healthcare industry; however, we have also
experienced increases in both the manufacturing market and the
construction and engineering market.§
    
    $27.6 million increase from contracts signed during the twelve-month
period following the third quarter of 2003. This revenue comes
primarily from new contracts signed in the healthcare, manufacturing,
and construction and engineering markets, and the services that we are
providing to these new customers are primarily the same services that
we provide to the majority of our other long-term outsourcing
customers. Page 22




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  §
    
    $26.4 million increase associated with an outsourcing contract signed
during the first quarter of 2003 with a customer in the healthcare
industry for which we did not recognize a full quarter of revenue
until the third quarter of 2003 because of the timing of the contract
signing and subsequent contract start date. This contract was subject
to regulatory approval before work could commence. We received that
approval late during the second quarter of 2003.§
    
    Partially offsetting these increases was a $34.6 million decrease in
revenue associated with three major customer contract changes. As
discussed above in Exiting of a Customer Contract, we exited an
under-performing contract during the second quarter of 2003, resulting
in a $21.3 million decrease in revenue for the first nine months of
2004 as compared to the prior year period. Additionally, we completed
two major contract renewals that resulted in a revenue reduction of
$13.3 million for the first nine months of 2004 as compared to the
first nine months of 2003, primarily relating to reductions in price.
The circumstances for these reductions are discussed above in our
three month comparison of revenue. Revenue from the Government Services segment increased $53.4 million, or 36.2%,
to $201.0 million for the first nine months of 2004 from $147.6 million for the
first nine months of 2003. This increase is primarily attributable to new
contracts and existing program expansion with the Department of Homeland
Security, the Department of Defense, and civilian agencies of the federal
government. For the contracts underlying this revenue increase, we are
providing program management, administrative, professional and engineering
services related to both a recently awarded program by the Department of
Homeland Security and from existing programs where specific initiatives of the
government required additional resources for the first nine months of 2004 as
compared to the same period in the prior year. Our business with the federal
government may fluctuate due to annual federal funding limits and the specific
needs of the federal agencies we serve. The remaining year-to-year increase is
primarily attributable to the acquisition of Soza & Company, Ltd. in February
2003 as we recognized approximately $21.8 million of additional revenue in the
first quarter of 2004 resulting from a full quarter of revenue in our financial
statements. Revenue from the Consulting segment increased 267.4% to $127.5 million for the
first nine months of 2004, net of the elimination of intersegment revenue of
$20.2 million, from $34.7 million for the first nine months of 2003. This
increase is primarily attributable to the acquisition of TSI, which contributed
$86.2 million of revenue, net of the elimination of intersegment revenue of
$20.2 million, for the first nine months of 2004. The remaining increase
results from increased revenue from technology and business consulting
services, primarily attributable to an increased level of services related to
the implementation of packaged software applications. These services are
typically viewed as discretionary services by our customers with the level of
business activity depending on many factors including economic conditions and
specific customer needs. Revenue from UBS, our largest customer, was $203.8 million for the first nine
months of 2004, or 15.6% of revenue. This revenue is reported within the IT
Solutions and Consulting lines of business and is summarized in the following
table: Nine Months Ended September 302004
    
    2003
    
    ChangeUBS revenue in IT Solutions
    
    $
    179.8
    
    
    $
    177.5
    
    
    
    1.3
    %UBS revenue in Consulting
    
    
    24.0
    
    
    
    
    
    
    
    n/mTotal revenue from UBS
    
    $
    203.8
    
    
    $
    177.5
    
    
    
    14.8
    %
 The increase in revenue from UBS for the IT Solutions line of business for the
third quarter of 2004 as compared to the prior year period is due primarily to
a change in our estimate of the variable component of our annual fee following
the execution of the Transition Agreement between us and UBS. The increase in
revenue from UBS for the Consulting line of business is due to the acquisition
of TSI as discussed above. Page 23




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Gross Margin Gross margin, which is calculated as gross profit divided by revenue, for the
nine months ended September 30, 2004, was 20.7% of total revenue, which is
higher than the gross margin for the nine months ended September 30, 2003, of
17.5% of total revenue. This year-to-year increase in gross margin is primarily
due to the following:  §
    
    As discussed above in Exiting of a Customer Contract, in the second
quarter of 2003, we recorded $17.7 million of expense in direct costs
of services associated with the exiting of this contract.§
    
    The acquisition of TSI increased gross margin by 1.5 percentage points
for the first nine months of 2004. TSI was acquired during the
twelve-month period following the third quarter of 2003 and typically
realizes higher gross margins than what we normally realize on
traditional IT outsourcing contracts because of the nature of the
services they provide, which are offshore business process outsourcing
and application management services.§
    
    An overall net increase in profitability for existing commercial
customer contracts, which is primarily due to an increase in the
amount of services we perform that are in addition to our base level
of services, changes in our estimates of the variable component of our
annual fee from UBS, software license fees of $3.2 million that are
not expected to recur in the fourth quarter of 2004, and profit from a
contract signed during the first quarter of 2003 for which we did not
recognize a full quarter of profit until the third quarter of 2003.
The increased services are discretionary in nature, and the associated
gross margins are typically higher than those we realize on our base
level of services. As discussed above, we have seen increased demand
for discretionary investment from several customers, primarily in the
healthcare industry. Partially offsetting these increases were the three major customer contract
changes discussed above, which reduced gross margin by 1.5 percentage points,
and an increase in expense of $13.6 million for year-end bonuses for the
majority of the associates in our IT Solutions segment. We have several
separate bonus plans for various associate groups within our Government
Services and Consulting segments, and the impact on gross margin from the bonus
expense recorded under these other plans did not differ significantly for the
first nine months of 2004 as compared to the same prior year period. Selling, General and Administrative Expenses Selling, general and administrative expenses for the nine months ended
September 30, 2004, increased 23.9% to $170.1 million from $137.3 million for
the nine months ended September 30, 2003. SG&A for the first nine months of
2004 was 13.0% of revenue, which is slightly higher than SG&A for the first
nine months of 2003 of 12.9% of revenue. This increase is primarily
attributable to the acquisition of TSI, which added $20.1 million of SG&A
expense, an increase of $4.1 million in expenses associated with corporate
compliance and business insurance, and $2.6 million of expense associated with
exiting a leased facility, partially offset by reduced SG&A expenses primarily
resulting from cost reductions made in 2003. During the first nine months of
2003, we recorded the following items in SG&A:  §
    
    Expense of $3.3 million related to severance and other costs to
eliminate approximately 150 positions in various business functions
and geographic areas.§
    
    A reduction of expense of $6.3 million resulting from revising our
estimate of liabilities associated with actions in prior years to
streamline our operations, which included a favorable resolution of an
employment dispute. Page 24




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Other Statement of Operations Items Interest expense for the nine months ended September 30, 2004 increased by $1.4
million as compared to the nine months ended September 30, 2003. This increase
is primarily related to the debt we recorded on our consolidated balance sheet
as of December 31, 2003, upon adoption of Financial Accounting Standards Board
Interpretation No. 46, Consolidation of Variable Interest Entities. During the nine months ended September 30, 2003, we recorded $4.7 million of
income from our previous 50% equity in the earnings of TSI, which we
consolidated on December 31, 2003, following the acquisition of HCL
Technologies shares in TSI. Other income for the nine months ended September 30, 2004 decreased $1.8
million as compared to the nine months ended September 30, 2003. This decrease
is primarily due to the receipt of a $1.2 million non-investment interest
payment in the first nine months of 2003 and the recognition of foreign
exchange losses during the first nine months of 2004, partially offset by the
gains recorded from the sale of short-term investments held by TSI. Our effective tax rate for the nine months ended September 30, 2004 was 33.6%.
Our effective tax rate for income before cumulative effect of a change in
accounting principle for the nine months ended September 30, 2003 was 39.0%.
The tax rate for the first nine months of 2004 was lower than the rate for the
first nine months of 2003 due to the impact of our foreign operations,
including TSI, which has tax holidays in certain Asian jurisdictions exempting
specific types of income from taxation, and a reduction in income tax expense
of $3.2 million relating to the resolution of various outstanding tax issues
from prior years. LIQUIDITY AND CAPITAL RESOURCES Our primary sources of liquidity are cash flows from operations, available cash
reserves, and debt capacity under a revolving credit facility. During the nine
months ended September 30, 2004, cash and cash equivalents increased 85.9% to
$230.2 million from $123.8 million at December 31, 2003. Net cash provided by operating activities was $84.0 million for the nine months
ended September 30, 2004, as compared to net cash provided by operating
activities of $77.3 million for the nine months ended September 30, 2003.
Income before cumulative effect of a change in accounting principle, net of
tax, increased for the first nine months of 2004 to $67.2 million as compared
to $35.5 million for the first nine months of 2003. The following items also
impacted our cash flow from operations in 2004 as compared to 2003:  §
    
    Because we typically collect our accounts receivable within 45 to 60
days, our accounts receivable balance at the end of each quarterly
period can change based on the amount of revenue for that quarter and
the timing of collections from our customers, which can vary from
period to period. During the first nine months of 2004, accounts
receivable increased by $27.1 million as compared to a decrease in
accounts receivable of $7.2 million for the same prior year period.
This increase is primarily due to an $83.0 million increase in revenue
for the third quarter of 2004 as compared to the third quarter of
2003, which is significantly higher than the $28.8 million revenue
increase in the third quarter of 2003 as compared to the same period
in 2002.§
    
    Year-end bonuses paid in 2004 primarily to associates in the IT
Solutions segment and in our corporate SG&A operating areas increased
as compared to 2003 by approximately $11.1 million. The amount of
year-end bonuses that we record for each period is based on several
factors, including our financial performance for the period and
managements discretion.§
    
    Net cash paid for income taxes for the first nine months of 2004
increased by $20.7 million as compared to the prior year period, with
net payments of $17.7 million in 2004 compared to net refunds of $3.0
million in 2003. Page 25




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  §
    
    During the first nine months of 2004 we increased our spending on
deferred contract costs by approximately $21.1 million as compared to
the first nine months of 2003, which are included in other non-current
assets on the condensed consolidated balance sheets. Partially
offsetting this increase in spending is an increase in customer
deferred revenue, which is included in other non-current liabilities
on the condensed consolidated balance sheets. Net cash provided from investing activities increased to $6.6 million for the
nine months ended September 30, 2004, as compared to net cash used of $110.7
million for the same period in 2003. This increase was due primarily to a $79.9
million decrease in the amount of net cash paid for acquisitions of businesses.  §
    
    During the nine months ended September 30, 2003, we paid $88.7 million
(net of cash received) for acquisitions, including $73.5 million (net
of cash received) for the acquisition of Soza and an additional $10.0
million for the acquisition of ARS.§
    
    During the nine months ended September 30, 2004, we paid $8.8 million
for acquisitions, including $6.3 million and $2.5 million as
additional consideration related to the acquisitions of Soza and ADI,
respectively.§
    
    During the nine months ended September 30, 2004, we recorded $37.7
million of net proceeds from the sale of short-term investments
relating to the conversion of TSIs short-term investments to cash and
cash equivalents. For the nine months ended September 30, 2004, net cash provided by financing
activities increased to $15.6 million compared to $6.4 million for the nine
months ended September 30, 2003. This increase is due primarily to an increase
in the amount of cash received upon the exercise of options to purchase Class A
Common Stock and from the purchases of stock through the Employee Stock
Purchase Plan during the first nine months of 2004 as compared to the same
period in 2003. We routinely maintain cash balances in certain European and Asian currencies to
fund operations in those regions. During the nine months ended September 30,
2004, foreign exchange rate fluctuations had a net positive impact on our
non-domestic cash balances by $0.2 million as the British pound strengthened
against the U.S. dollar and the Euro and the Indian rupee weakened against the
U.S. dollar. Our foreign exchange policy does not call for hedging foreign
exchange exposures that are not likely to impact net income or working capital. On January 20, 2004, we entered into a revolving credit facility with a
syndicate of banks that allows us to borrow up to $100.0 million. We anticipate
that existing cash and cash equivalents and short-term investments, expected
cash flows from operating activities, and the $100.0 million available under
the revolving credit facility will provide us sufficient funds to meet our
operating needs for the foreseeable future. Current Portion of Long-Term Debt In June 2000, we entered into an operating lease contract with a variable
interest entity for the use of land and office buildings in Plano, Texas,
including a data center facility. As part of our adoption of Financial
Accounting Standards Board Interpretation No. 46, Consolidated Financial
Statements, we began consolidating this entity beginning on December 31, 2003.
Upon consolidation, we recorded the long-term debt between the variable
interest entity and the financial institutions (the lenders) of $75.5 million
as our long-term debt. The agreement matures in June 2005 with one optional two
year extension. We are currently pursuing plans to refinance the obligation and
consequently do not expect to exercise our option to extend the agreement. As
a result, the amount outstanding of $75.5 million is included in the current
portion of long-term debt on our condensed consolidated balance sheets. Page 26




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS Purchase Commitment We have an agreement with a telecommunication service provider to purchase
services from, or sell services on behalf of, this provider having a gross
value of $19.5 million over a four-year commitment period. We entered into
arbitration with this vendor in 2003 and had recorded a liability for our
estimate of the unfulfilled minimum purchase commitment of $5.6 million at
December 31, 2003. The arbitration concluded in the first quarter of 2004, and
based on the outcome, we recorded an additional liability of $3.2 million
through a charge to direct cost of services. The total liability recorded
through the first quarter of 2004 of $8.8 million relates to the unfulfilled
minimum purchase commitment for the first three years of the commitment period,
which ended on March 31, 2004. We currently expect to fulfill the minimum
purchase commitment for the final year of the commitment period that ends on
March 31, 2005. FORWARD-LOOKING STATEMENTS This quarterly report contains forward-looking statements. These statements
relate to future events or our future financial performance. In some cases, you
can identify forward-looking statements by terminology such as may, will,
should, could, forecasts, expects, plans, anticipates, believes,
estimates, predicts, potential, see, target, projects, position,
or continue or the negative of such terms and other comparable terminology.
These statements are our current expectations, estimates and projections.
These statements are not guarantees of future performance and involve risks,
uncertainties and assumptions that are difficult to predict. Actual events or
results may differ materially from what is expressed or forecast in these
forward-looking statements. In evaluating all forward-looking statements, you
should specifically consider various factors that may cause actual results to
vary from those contained in the forward-looking statements, such as:  §
    
    Our outsourcing agreement with UBS, the largest of our UBS agreements, ends in January 2007, which we expect to result in
the loss of a substantial majority of revenue and profits from our UBS relationship.§
    
    Revenue and profits from our contract with UBS may substantially vary between periods because it depends on the amount and
quality of the services we provide.§
    
    We may bear the risk of cost overruns under custom software development contracts, and, as a result, cost overruns could
adversely affect our profitability.§
    
    Our five largest customers account for a substantial portion of our revenue and profits and loss of any of these customers
could result in decreased revenues and profits.§
    
    If entities we acquire fail to perform in accordance with our expectations or if their liabilities exceed our expectations,
our profits per share could be diminished and our financial results could be adversely affected.§
    
    Our software development products may cost more than we initially project, encounter delays, or fail to perform well in the
market, which could decrease our profits.§
    
    Our financial results are materially affected by a number of factors, including broad economic conditions, the amount and
type of technology spending that our customers undertake, and the business strategies and financial condition of our
customers and the industries we serve, which could result in increases or decreases in the amount of services that we
provide to our customers and the pricing of such services. Important to our future financial and growth position is our
ability to identify and effectively respond to these factors.§
    
    The success of the implementation of planned operating efficiencies and cost cutting initiatives is uncertain, as well as
the timing and amount of any resulting benefits.§
    
    If we are unable to successfully integrate acquired entities, our profits may be less and our operations more costly or
less efficient.§
    
    Our contracts generally contain provisions that could allow customers to terminate the contracts and sometimes contain
provisions that enable the customer to require changes in pricing, decreasing our revenue and profits and potentially
damaging our business reputation.§
    
    Some contracts contain fixed-price provisions or penalties that could result in decreased profits.§
    
    Fluctuations in currency exchange rates may adversely affect the profitability of our foreign operations. Page 27




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS  §
    
    Our international operations expose our assets to increased risks and could result in business loss or in more expensive or
less efficient operations.§
    
    We have a significant business presence in India, and risks associated with doing business there could decrease our revenue
and profits.§
    
    Governments could enact legislation that restricts the provision of services from offshore locations.§
    
    Our government contracts contain early termination and reimbursement provisions that may adversely affect our revenue and
profits.§
    
    If customers reduce spending that is currently above contractual minimums, our revenues and profits could diminish.§
    
    If we fail to compete successfully in the highly competitive markets in which we operate, our business, financial
condition, and results of operations will be materially and adversely affected.§
    
    Increasingly complex regulatory environments may increase our costs.§
    
    Our quarterly operating results may vary.§
    
    Loss of key personnel could adversely affect our ability to attract and retain business.§
    
    Changes in technology could adversely affect our competitiveness, revenue, and profit.§
    
    Ross Perot has substantial control over any major corporate action.§
    
    We could lose rights to our company name, which may adversely affect our ability to market our services.§
    
    Failure to recruit, train, and retain technically skilled personnel could increase costs or limit growth.§
    
    Alleged or actual infringement of intellectual property rights could result in substantial additional costs.§
    
    Provisions of our certificate of incorporation, bylaws, stockholders rights plan and Delaware law could deter takeover
attempts. Please refer to our Annual Report on Form 10-K/A for the fiscal year ended
December 31, 2003, as filed with the U.S. Securities and Exchange Commission
and available at www.sec.gov, for additional information regarding risk
factors. We disclaim any intention or obligation to revise any forward-looking
statements whether as a result of new information, future developments, or
otherwise. Page 28




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
FORM 10-Q
For the Quarter Ended September 30, 2004 
 ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For a discussion of our market risk associated with foreign currencies as of
December 31, 2003, see Quantitative and Qualitative Disclosures about Market
Risk in Part II, Item 7A, Managements Discussion and Analysis of Financial
Condition and Results of Operations, of our Annual Report on Form 10-K/A for
the fiscal year then ended. For the nine months ended September 30, 2004,
there has been no material change in related market risk factors. 
 ITEM 4: CONTROLS AND PROCEDURES As of the end of the period covered by this report, an evaluation was carried
out by our management, with the participation of our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls
and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act
of 1934). Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that these disclosure controls and procedures were
effective. There were no changes in internal control over financial reporting (as defined
in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred
during our most recent fiscal quarter that have materially affected, or are
reasonably likely to materially affect, internal control over financial
reporting. Page 29




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
FORM 10-Q
For the Quarter Ended September 30, 2004 
 PART II: OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS We are involved in the following legal proceedings. IPO Allocation Securities Litigation In July and August 2001, we, as well as some of our current and former officers
and the investment banks that underwrote our initial public offering, were
named as defendants in two purported class action lawsuits. These lawsuits,
Seth Abrams v. Perot Systems Corp. et al. and Adrian Chin v. Perot Systems,
Inc. et al., were filed in the United States District Court for the Southern
District of New York. The suits allege violations of Rule 10b-5, promulgated
under the Securities Exchange Act of 1934, and Sections 11, 12(a)(2) and 15 of
the Securities Act of 1933. Approximately 300 issuers and 40 investment banks
have been sued in similar cases. The suits against the issuers and
underwriters have been consolidated for pretrial purposes in the IPO Allocation
Securities Litigation. The lawsuit involving us focuses on alleged improper
practices by the investment banks in connection with our initial public
offering in February 1999. The plaintiffs allege that the investment banks, in
exchange for allocating public offering shares to their customers, received
undisclosed commissions from their customers on the purchase of securities and
required their customers to purchase additional shares in aftermarket trading.
The lawsuit also alleges that we should have disclosed in our public offering
prospectus the alleged practices of the investment banks, whether or not we
were aware that the practices were occurring. The plaintiffs are seeking
unspecified damages, statutory compensation and costs and expenses of the
litigation. During 2002, the current and former officers and directors of Perot Systems
Corporation that were individually named in the lawsuits referred to above were
dismissed from the cases. In exchange for the dismissal, the individual
defendants entered agreements with the plaintiffs that toll the running of the
statute of limitations and permit the plaintiffs to refile claims against them
in the future. In February 2003, in response to the defendants motion to
dismiss, the court dismissed the plaintiffs Rule 10b-5 claims against us, but
did not dismiss the remaining claims. We have accepted a settlement proposal presented to all issuer defendants.
Pursuant to the proposed settlement, plaintiffs would dismiss and release all
claims against us and our current and former officers and directors, in
exchange for an assurance by the insurance companies collectively responsible
for insuring the issuers in all of the IPO cases that the plaintiffs will
achieve a minimum recovery (including amounts recovered from the underwriters),
and for the assignment or surrender of certain claims we may have against the
underwriters. We would not be required to make any cash payment with respect
to the settlement. The proposed settlement would also require court approval,
which cannot be assured. The underwriters are opposing approval of the
proposed settlement and have requested that, if the settlement is approved,
they receive a corresponding reduction in any judgment amounts that they may be
ordered to pay if they are found liable in the actions. Litigation Relating to the California Energy Market In June 2002, we were named as a defendant in a purported class action lawsuit
that alleges that we conspired with energy traders to manipulate the California
energy market. This lawsuit, Art Madrid v. Perot Systems Corporation et al.,
was filed in the Superior Court of California, County of San Diego. The case
is currently pending in the Superior Court for the County of Sacramento. The
plaintiffs are seeking unspecified damages, treble damages, restitution,
punitive damages, interest, costs, attorneys fees and declaratory relief. In
September 2003, we filed a demurrer to the complaint and an alternative motion
to strike all claims for monetary relief. In January 2004, the court granted
our demurrer and did not grant the plaintiffs leave to amend their complaint.
The plaintiffs, however, have appealed. Page 30




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
FORM 10-Q
For the Quarter Ended September 30, 2004 In June, July and August 2002, Perot Systems, Ross Perot and Ross Perot, Jr.,
were named as defendants in eight purported class action lawsuits that allege
violations of Rule 10b-5, and, in some of the cases, common law fraud. These
suits allege that our filings with the Securities and Exchange Commission
contained material misstatements or omissions of material facts with respect to
our activities related to the California energy market. All of these eight
cases have been consolidated in the Northern District of Texas, Dallas Division
in the case of Vincent Milano v. Perot Systems Corporation. The plaintiffs in
this case filed a consolidated amended complaint in July 2003. The plaintiffs
are seeking unspecified monetary damages, interest, attorneys fees and costs.
In October 2003, we moved to dismiss the amended complaint with prejudice. In
October 2004, the court dismissed the suit without prejudice. The plaintiffs
have the right to amend their complaint. Other In addition to the matters described above, we have been, and from time to time
are, named as a defendant in various legal proceedings in the normal course of
business, including arbitrations, class actions and other litigation involving
commercial and employment disputes. Certain of these proceedings include
claims for substantial compensatory or punitive damages or claims for
indeterminate amounts of damages. In view of the inherent difficulty of predicting the outcome of such matters,
particularly in cases in which claimants seek substantial or indeterminate
damages, we cannot predict with certainty the eventual loss or range of loss
related to such matters. We are contesting liability and/or the amount of
damages, in each pending matter and believe, based on current knowledge and
after consultation with counsel, that the outcome of these matters will not
have a material adverse effect on our consolidated financial condition,
although the outcome could be material to our operating results for a
particular future period, depending on, among other things, the level of our
income for such period. We have purchased, and expect to continue to purchase, insurance coverage that
we believe is consistent with coverage maintained by others in the industry.
This coverage is expected to limit our financial exposure to claims covered by
these policies in many cases. 
 ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS We did not submit any matters to a vote of our security holders during the
period covered by this report. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits required by Item 601 of Regulation S-K Exhibit No.
    
    Document31.1*
    
    Rule 13a-14 Certification dated November 2,
2004, by Peter A. Altabef, President and Chief Executive
Officer.31.2*
    
    Rule 13a-14 Certification dated November 2,
2004, by Russell Freeman, Vice President and Chief Financial
Officer.32.1**
    
    Section 1350 Certification dated November 2, 2004, by Peter
A. Altabef, President and Chief Executive Officer.
 Page 31




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
FORM 10-Q
For the Quarter Ended September 30, 2004 Exhibit No.
    
    Document32.2**
    
    Section 1350 Certification dated November 2, 2004, by
Russell Freeman, Vice President and Chief Financial Officer.
   (b) Reports on Form 8-KOn September 16, 2004, the Company filed a Current Report on Form 8-K to
report the departure of a principal officer. The matter was reported
under Item 5.02 of Form 8-K.On September 20, 2004, the Company filed a Current Report on Form 8-K to
report entry into a material definitive agreement. The matter was
reported under Item 1.01 of Form 8-K.On September 24, 2004, the Company filed a Current Report on Form 8-K to
report a press release and the adoption of amendments to its bylaws.
These matters were reported under Items 5.02 and 5.03 of Form 8-K.On September 27, 2004, the Company filed a Current Report on Form 8-K to
report a press release. The matter was reported under Item 8.01 of Form
8-K.  *
    
    Filed herewith.**
    
    Furnished herewith. Page 32




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PEROT SYSTEMS CORPORATION AND SUBSIDIARIES
FORM 10-Q
For the Quarter Ended September 30, 2004 
 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. PEROT SYSTEMS CORPORATION(Registrant)Date: November 2, 2004
    
    By
    /s/ ROBERT J. KELLYRobert J. KellyCorporate Controller and PrincipalAccounting Officer
 Page 33