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CSC > SEC Filings for CSC > Form 10-Q on 8-Aug-2012All Recent SEC Filings

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Form 10-Q for COMPUTER SCIENCES CORP


8-Aug-2012

Quarterly Report

PART I, ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
First Quarter of Fiscal 2013 versus
First Quarter of Fiscal 2012

All statements and assumptions in this quarterly report on Form 10-Q and in the documents attached or incorporated by reference that do not directly and exclusively relate to historical facts constitute "forward-looking statements" within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements represent current expectations and beliefs of CSC, and no assurance can be given that the results described in such statements will be achieved.

Forward-looking information contained in these statements include, among other things, statements with respect to the Company's financial condition, results of operations, cash flows, business strategies, operating efficiencies or synergies, competitive positions, growth opportunities, plans and objectives of management, and other matters. Such statements are subject to numerous assumptions, risks, uncertainties and other factors, many of which are outside of the Company's control, which could cause actual results to differ materially from the results described in such statements. These forward looking statements should be read in conjunction with our Annual Report on Form 10-K. The reader should specifically consider the various risks discussed in the Risk Factors section included elsewhere herein.

Forward-looking statements in this quarterly report on Form 10-Q speak only as of the date hereof, and forward-looking statements in documents attached or incorporated by reference speak only as to the date of those documents. The Company does not undertake any obligation to update or release any revisions to any forward-looking statement or to report any events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, except as required by law.

General

The following discussion and analysis provides information management believes relevant to an assessment and understanding of the consolidated results of operations and financial condition of Computer Sciences Corporation (CSC or the Company). The discussion should be read in conjunction with the interim Consolidated Condensed Financial Statements and notes thereto and the Company's Annual Report on Form 10-K for the fiscal year ended March 30, 2012. The following discusses the Company's results of operations and financial condition as of and for the first quarter ended June 29, 2012, and the comparable period of the prior fiscal year.

First Quarter Overview

The key operating results for the first quarter of fiscal 2013 include:

Revenues decreased $76 million or 1.9%, and increased 0.7% on a constant currency basis(1). The revenue decrease includes an increase in revenue of 2.3% from the fiscal 2012 acquisitions.

Income from continuing operations before taxes was $74 million, compared to $101 million in the first quarter of fiscal 2012, a decrease of $27 million, or 26.7%.

Operating income(2) increased 1.7% to $183 million as compared to $180 million for the same period of fiscal 2012, and operating income margin increased to 4.62% from last year's first quarter margin of 4.46%.

Earnings before interest and taxes(3) (EBIT) of $114 million decreased by $17 million from the first quarter of fiscal 2012. EBIT margin declined to 2.9% from last year's first quarter margin of 3.2%.

Net income attributable to CSC common shareholders was $40 million, a decrease of $143 million, or 78.1%, as compared to the same period in the prior year, primarily driven by a first quarter fiscal 2012 discrete tax benefit of $121 million, which did not recur in the first quarter of fiscal 2013.

Diluted earnings per share (EPS) was $0.26 for the first quarter of fiscal 2013, a decrease of $0.91 as compared to the same period in the prior year.


The Company announced contract awards of $4.0 billion, including new NPS segment awards of $0.9 billion, MSS segment awards of $2.2 billion, and BSS segment awards of $0.9 billion. Total backlog(4) at the end of the first quarter of fiscal 2013 was $36.1 billion, an increase of $0.6 billion as compared to the backlog at the end of fiscal 2012 of $35.5 billion. Of the total $36.1 billion backlog, $8.4 billion is expected to be realized as revenue in the remainder of fiscal 2013. Of the total $36.1 billion, $12 million is not yet funded.

Days Sales Outstanding (DSO)(5) was 72 days at June 29, 2012, an improvement from 87 days at the end of the first quarter of the prior fiscal year. A contract settlement with the U.S. Government as well as operational improvements contributed to the DSO improvement.

Debt-to-total capitalization ratio(6) was 49.9% at June 29, 2012, an increase of 0.7 percentage points from 49.2% at March 30, 2012, primarily due to a reduction in equity from foreign currency translation adjustments.

Cash provided by operating activities was $221 million, as compared to cash used of $46 million for the first quarter of fiscal 2012.

Cash used in investing activities was $179 million, as compared to $334 million for the first quarter of fiscal 2012.

Cash used in financing activities was $97 million, as compared to cash provided of $194 million for the first quarter of fiscal 2012.

Free cash flow(7) of $(25) million for the first quarter of fiscal 2013 was favorable to the $(403) million for the first quarter of fiscal 2012, driven primarily by reduced payments for purchases for property and equipment and software, and improved operating cash flow primarily due to higher collections of accounts receivable.

(1) Selected references are made on a "constant currency basis" so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby providing comparisons of operating performance from period to period. Financial results on a "constant currency basis" are calculated by translating current period activity into U.S. dollars using the comparable prior period's currency conversion rates. This approach is used for all results where the functional currency is not the U.S. dollar.

(2) Operating income is a non-U.S. Generally Accepted Accounting Principle (GAAP) measure used by management to assess performance at the segments and on a consolidated basis. The Company's definition of such measure may differ from other companies. We define operating income as revenue less costs of services, depreciation and amortization expense, restructuring costs and segment general and administrative (G&A) expense, excluding corporate G&A. Operating margin is defined as operating income as a percentage of revenue. Management compensates for the limitations of this non-GAAP measure by also reviewing income (loss) from continuing operations before taxes, which includes costs excluded from the operating income definition such as goodwill impairment, corporate G&A, interest and other income (expense). A reconciliation of consolidated operating (loss) income to (loss) income from continuing operations before taxes is as follows:

                                                          Quarter Ended
(Amounts in millions)                             June 29, 2012     July 1, 2011
Operating income                                 $         183     $        180
Corporate G&A                                              (60 )            (54 )
Interest expense                                           (45 )            (42 )
Interest Income                                              5               12
Other income (expense), net                                 (9 )              5
Income from continuing operations before taxes   $          74     $        101


(3) Earnings before interest and taxes (EBIT) is a non-U.S. Generally Accepted Accounting Principle (GAAP) measure that provides useful information to investors regarding the Company's results of operations as it provides another measure of the Company's profitability, and is considered an important measure by financial analysts covering CSC and its peers. The Company's definition of such measure may differ from other companies. We define EBIT as revenue less costs of services, selling, general and administrative expenses, depreciation and amortization, goodwill impairment, restructuring costs, and other income (expense). EBIT margin is defined as EBIT as a percentage of revenue. A reconciliation of EBIT to net income from continuing operations is as follows:

                                                 Quarter Ended
(Amounts in millions)                    June 29, 2012     July 1, 2011
Earnings before interest and taxes      $         114     $        131
Interest expense                                  (45 )            (42 )
Interest Income                                     5               12
Taxes on Income                                   (32 )             85
Net Income from continuing operations   $          42     $        186

(4) Backlog represents total estimated contract value of predominantly long-term contracts, based on customer commitments that the Company believes to be firm. Backlog value is based on contract commitments, management's judgment and assumptions about volume of services, availability of customer funding and other factors. Backlog estimates for government contracts include both the funded and unfunded portions and all of the option periods. Backlog estimates are subject to change and may be affected by factors including modifications of contracts and foreign currency movements.

For NPS, announced award values for competitive indefinite delivery and indefinite quantity (IDIQ) awards represent the expected contract value at the time a task order is awarded under the contract. Announced values for non-competitive IDIQ awards represent management's estimate at the award date. Business awards for MSS are estimated at the time of contract signing based on then existing projections of service volumes and currency exchange rates, and include option years. BSS award values are based on firm commitments.

(5) DSO is calculated as total receivables at the fiscal period end divided by revenue-per-day. Revenue-per-day equals total revenues divided by the number of days in the fiscal period. Total receivables includes unbilled receivables but excludes income tax receivables and long-term receivables.

(6) Debt-to-total capitalization ratio is defined as total current and long-term debt divided by total debt and equity, including noncontrolling interest.

(7) Free cash flow is a non-GAAP measure and the Company's definition of such measure may differ from that of other companies. We define free cash flow as equal to the sum of (1) operating cash flows, (2) investing cash flows, excluding business acquisitions, dispositions and investments (including short-term investments and purchase or sale of available for sale securities) and (3) payments on capital leases and other long-term asset financings.

CSC's free cash flow measure does not distinguish operating cash flows from investing cash flows as they are required to be presented in accordance with GAAP, and should not be considered a substitute for operating and investing cash flows as determined in accordance with GAAP. Free cash flow is one of the factors CSC management uses in reviewing the overall performance of the business. Management compensates for the limitations of this non-GAAP measure by also reviewing the GAAP measures of operating, investing and financing cash flows as well as debt levels measured by the debt-to-total capitalization ratio.

A reconciliation of free cash flow to the most directly comparable GAAP financial measure is presented below:

                                                                  Quarter Ended
(Amounts in millions)                                  June 29, 2012         July 1, 2011
Free cash flow                                       $            (25 )   $          (403 )
Net cash used in investing activities                             179                 334
Acquisitions, net of cash acquired                                  -                  (8 )
Business dispositions                                               2                   -
Short-term investments                                              -                  (6 )
Payments on capital leases and other long-term                     65                  37
asset financings
Net cash provided by (used in) operating             $            221     $           (46 )
activities
Net cash used in investing activities                $           (179 )   $          (334 )
Net cash (used in) provided by financing             $            (97 )   $           194
activities


Reportable Segments

CSC provides information technology (IT) and business process outsourcing, consulting and systems integration services and other professional services to its customers. The Company targets the delivery of these services within three broad service lines or sectors: North American Public Sector (NPS), Managed Services Sector (MSS), and Business Solutions and Services (BSS).

The Company's reportable segments in fiscal 2013 and 2012 are as follows:

The NPS segment operates principally within a regulatory environment subject to governmental contracting and accounting requirements, including Federal Acquisition Regulations, Cost Accounting Standards and audits by various U.S. federal agencies.

The MSS segment provides large-scale infrastructure and application outsourcing solutions offerings as well as mid-size services delivery to customers globally.

The BSS segment provides industry specific consulting and systems integration services, business process outsourcing, and intellectual property-based software solutions.

Results of Operations

Revenues

Revenues for the NPS, MSS, and BSS segments for the first quarter of fiscal 2013
and fiscal 2012 are as follows:
                                             Quarter Ended
                                                                        Percent
(Amounts in millions)     June 29, 2012      July 1, 2011     Change     Change
NPS                     $         1,368     $      1,484     $ (116 )    (7.8 )%
MSS                               1,635            1,619         16       1.0
BSS                                 985              961         24       2.5
Corporate                             3                3
Subtotal                          3,991            4,067        (76 )    (1.9 )
Eliminations                        (34 )            (34 )
Total Revenue           $         3,957     $      4,033     $  (76 )    (1.9 )%

The major factors affecting the percent change in revenues for the first quarter ended June 29, 2012 are presented as follows:

                                                 Quarter Ended
                                             Approximate
                                              Impact of
                                              Currency      Net Internal
                            Acquisitions    Fluctuations       Growth        Total
NPS                               0.7 %            -            (8.5 )%     (7.8 )%
MSS                               1.7           (3.8 )%          3.1         1.0
BSS                               5.6           (4.5 )           1.4         2.5
Cumulative Net Percentage         2.3 %         (2.6 )%         (1.6 )%     (1.9 )%


North American Public Sector

NPS segment revenues were derived from the following sources:
                                                 Quarter Ended
(Amounts in millions)                                                      Percent
                             June 29, 2012      July 1, 2011     Change     Change
Department of Defense (1)   $           921    $       1,016    $  (95 )    (9.4 )%
Civil Agencies (1)                      388              404       (16 )    (4.0 )
Other (2)                                59               64        (5 )    (7.8 )
Total                       $         1,368    $       1,484    $ (116 )    (7.8 )%

(1) Certain fiscal 2012 amounts were reclassified from Department of Defense to Civil Agencies to conform to the current year presentation.

(2) Other revenues consist of foreign, state and local government work as well as commercial contracts performed by the NPS segment.

NPS first quarter revenue decreased $116 million, or 7.8%, as compared to the first quarter of fiscal 2012. This decrease was due to revenue decreases in the Department of Defense group (DOD) contracts, which decreased $95 million, or 9.4%, revenue decreases from contracts with Civil Agencies, which decreased $16 million, or 4.0%, and revenue decreases from Other contracts, which decreased $5 million, or 7.8%.

The decrease in revenue on DOD contracts was due to a combination of completion of task orders on Iraq and Afghanistan related contracts and a contract termination, partially offset by net increases in scope and tasking on existing contracts. The decrease in revenue from Civil Agencies was primarily due to reduced scope on existing contracts, timing of certain contractual milestones, and contract termination, partially offset by increased revenue on new fiscal 2012 contracts.

NPS' first quarter revenue decrease continues to reflect the ongoing uncertainty in government budgets and the difficulties customers are facing in awarding new initiatives. Delays in award decisions continue to be the most significant issue in the industry, with delays ranging from six to eighteen months on submitted proposals.

In August 2011, President Obama signed into law the Budget Control Act of 2011, which increased the U.S. Government's debt ceiling and enacted 10-year discretionary spending caps expected to generate over $1 trillion in savings for the U.S. Government. According to the Office of Management and Budget, these savings include $487 billion in DOD baseline spending reductions over the next 10 years, starting in 2013. In addition, barring Congressional action, further budget cuts (or sequestration) as outlined in the Budget Control Act of 2011 will be implemented starting in January 2013. Sequestration would lead to additional reductions of approximately $500 billion from the Pentagon's top line budget over the next decade, resulting in aggregate reductions of about $1 trillion over 10 years. In June 2012, the Office of Management and Budget announced that the budget for Overseas Contingency Operations and any unobligated balances in prior year funds will also be included in aggregate reductions. The DOD has taken the position that such reductions would generate significant operational risks and may require the termination of certain, as yet undetermined, procurement programs. Any reduction in levels of DOD spending, cancellations or delays impacting existing contracts or programs, including through sequestration, could have a material impact on the operating results of the NPS business. While DOD would sustain the bulk of sequestration cuts affecting the Company, Civil Agencies may be significantly impacted as well.

During the first quarters of both fiscal 2013 and 2012, NPS won new contracts of $0.9 billion.

Managed Services Sector

MSS segment revenue increased $16 million, or 1.0%, as compared to the first quarter of fiscal 2012. In constant currency, revenue increased $78 million, or 4.8%. The adverse foreign currency impact was primarily due to the movement in the U.S. dollar against the Euro, the Danish Kroner and the British Pound. MSS' fiscal 2012 acquisition of AppLabs provided revenue of $28 million, or 1.7% of the revenue growth. Excluding the impact of foreign currency effects and the acquisition, net internal revenue for the first quarter increased $50 million, or 3.1% as compared to the same period in the prior year.

The increase in MSS' net internal revenue was primarily due to revenue from new client engagements acquired in fiscal 2012 and fiscal 2013 of $79 million, partially offset by revenue declining due to contract terminations, conclusions and


modifications of existing contracts of $43 million. MSS revenue comparisons were also favorably impacted by one time adverse revenue adjustments in the first quarter of fiscal 2012 which did not recur in fiscal 2013.

During the first quarter of fiscal 2013, the Company announced contract awards with a total value of $2.2 billion compared to $0.5 billion during the same period in fiscal 2012.

Business Solutions & Services

BSS segment revenue increased $24 million, or 2.5%, as compared to the first quarter of fiscal 2012. In constant currency, revenue increased $67 million, or 7.0%. The adverse foreign currency impact was due to the movement in the U.S. dollar primarily against the Euro, the Australian Dollar and the British Pound. The acquisition of iSOFT provided $54 million, or 5.6% of revenue increase. Excluding the impact of foreign currency and the iSOFT acquisition, revenue for the first quarter increased $13 million, or 1.4%, over the same period in the prior year.

The increase in BSS net internal revenue was primarily from a contract with the U.K.'s National Health Service (NHS) , mostly offset by a revenue decrease in a BSS value-added reseller business in Asia. Revenue on the NHS contract was higher by approximately $40 million primarily due to recording revenue from achieving a key milestone associated with the Lorenzo Care Management software. The milestone was related to delivering the patient administration software functionality to the NHS. Revenue was also favorably impacted by deployment of Lorenzo Care Management software at three NHS trust sites. The revenue from BSS' reseller business in Asia decreased due to conclusion of certain key contracts in the first quarter of fiscal 2012 and as a result revenue from these contracts did not recur.

BSS year-over-year revenue trend was also adversely impacted by out of period adjustments. Revenue for the first quarter of fiscal 2013 was adversely impacted by $7 million of out of period adjustments, whereas revenue for the first quarter of fiscal 2012 was favorably impacted by $7 million, resulting in a year-over-year adverse impact of $14 million (see Note 4 to the Consolidated Condensed Financial Statements).

During the first quarters of both fiscal 2013 and fiscal 2012, BSS had contract awards of $0.9 billion.

Costs and Expenses

The Company's total costs and expenses were as follows:
                                                                    Quarter Ended
                                             Amount                      Percentage of Revenue        Percentage Point
(Amounts in millions)            June 29, 2012      July 1, 2011    June 29, 2012     July 1, 2011         Change
Costs of services (excludes
depreciation and
amortization and
restructuring costs)           $         3,253     $      3,365            82.2 %         83.5  %         (1.3 )%
Selling, general and
administrative                             291              264             7.4            6.5             0.9
Depreciation and
amortization                               263              278             6.6            6.9            (0.3 )
Restructuring costs                         27                -             0.7              -             0.7
Interest expense, net                       40               30             1.0            0.7             0.3
Other (income) expense, net                  9               (5 )           0.2           (0.1 )           0.3
Total                          $         3,883     $      3,932            98.1 %         97.5  %          0.6  %


Investigations and Out of Period Adjustments

Summary of Audit Committee and SEC Investigations Related to the Out of Period Adjustments

Background

As previously disclosed in fiscal 2011 and fiscal 2012, the Company initiated an investigation into out of period adjustments resulting from certain accounting errors in our MSS segment, primarily involving accounting irregularities in the Nordic region. Initially, the investigation was conducted by Company personnel, but outside Company counsel and forensic accountants retained by such counsel later assisted in the Company's investigation. On January 28, 2011, the Company was notified by the SEC's Division of Enforcement that it had commenced a formal civil investigation relating to these matters, which investigation has subsequently been expanded to other matters subsequently identified by the SEC, including matters specified in subpoenas issued to the Company from time to time by the SEC's Division of Enforcement as well as matters under investigation by the Audit Committee of the Board of Directors, as further described below. The Company is cooperating in the SEC's investigation.

On May 2, 2011, the Audit Committee commenced an independent investigation into the matters relating to the MSS segment and the Nordic region, matters identified by subpoenas issued by the SEC's Division of Enforcement, and certain other accounting matters identified by the Audit Committee and retained independent counsel to represent CSC on behalf of, and under the exclusive direction of, the Audit Committee in connection with such independent investigation. Independent counsel retained forensic accountants to assist their work. Independent counsel also represents CSC on behalf of, and under the exclusive direction of, the Audit Committee in connection with the investigation by the SEC's Division of Enforcement.

The Audit Committee's investigation was expanded to encompass (i) the Company's operations in Australia, (ii) certain aspects of the Company's accounting practices within its Americas Outsourcing operation, and (iii) certain of the Company's accounting practices that involve the percentage of completion accounting method, including the Company's contract with the U.K. National Health Service (NHS). In the course of the Audit Committee's expanded investigation, accounting errors and irregularities were identified. As a result, certain personnel have been reprimanded, suspended, terminated and/or resigned. The Audit Committee determined in August 2012 that its independent investigation is complete and the Committee has instructed its independent counsel to cooperate with the SEC Division of Enforcement by completing production of documents and providing any further information requested by the SEC Division of Enforcement.
In fiscal 2012 and subsequently during fiscal 2013, certain additional items have been identified but not yet recorded related to the NHS contract that could have an effect on the amount and the allocation of the out of period adjustments for fiscal 2013 and prior fiscal years. At this time, management does not believe that the effect of these additional items will be material to the Company's financial statements. However, the Company's investigation into these additional items is ongoing, and the amount could change and the allocation across years is likely to change.

Any out of period adjustments identified, including items that self corrected . . .

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