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CSC > SEC Filings for CSC > Form 10-K on 22-May-2014All Recent SEC Filings

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Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations


The following discussion and analysis provides information management believes is relevant to an assessment and understanding of the consolidated results of operations and financial condition of the Company. This discussion should be read in conjunction with the Company's consolidated financial statements and associated notes as of and for the year ended March 28, 2014.

There are three primary objectives of this discussion:

1. Provide a narrative on the consolidated financial statements, as presented through the eyes of management;

2. Enhance the disclosures in the consolidated financial statements and footnotes by providing context within which the consolidated financial statements should be analyzed; and

3. Provide information to assist the reader in ascertaining the predictive value of the reported financial results.

To achieve these objectives, the management discussion and analysis is presented in the following sections:

Overview - includes a description of the Company's business, how it earns revenue and generates cash, as well as a discussion of economic and industry factors, key business drivers, key performance indicators and fiscal 2014 highlights.

Results of Operations - discusses year-over-year changes to operating results for fiscal 2012 through fiscal 2014, describing the factors affecting revenue on a consolidated and reportable segment basis, including new contracts, acquisitions and divestitures and currency impacts, and also describing the factors affecting changes in the Company's major cost and expense categories.

Financial Condition - discusses causes of changes in cash flows and describes the Company's liquidity and available capital resources.

Critical Accounting Estimates - discusses the significant accounting policies that require critical judgments and estimates.


CSC is a global leader of information technology (IT) and professional services and solutions. The Company's mission is to enable superior returns on our client's technology investments through best-in-class industry solutions, domain expertise and global scale.

During fiscal 2014, the Company continued to focus on its strategy on leading the next-generation of IT services and solutions. CSC has undertaken numerous organizational and operational changes to align the company's leadership, assets, and operating model with this strategy. The new operating model supports the execution of CSC's strategy by facilitating the effective development, sales and support of a portfolio of next-generation offerings for commercial and government clients. The redesigned operating model, which came into effect at the beginning of fiscal 2014, resulted in a change to the Company's reportable segments for fiscal 2014 and going forward.

The Company's new reportable segments are as follows:

Global Business Services (GBS) - GBS provides innovative, high-value technology solutions including consulting, applications services, and software, which address key business challenges within the customer's industry. GBS strives to help clients understand and exploit industry trends of IT modernization and virtualization of the IT portfolio ( hardware, software, networking, storage and computing assets). GBS has three primary growth engines: end-to-end applications services; value-driven consulting services; and industry aligned next-generation software and solutions. Applications Services optimize and modernize clients' business and technical environments, enabling clients to capitalize on emerging services such as cloud, mobility, and big data within new commercial models such as the "as a Service" and digital economies. The consulting business helps organizations innovate, transform, and create sustainable competitive advantage through a combination of

industry, business process, technology, systems integration and change management expertise. The industry software & solutions unit's vertically-aligned software solutions and process-based intellectual property power mission-critical transaction engines in insurance, banking, healthcare and life sciences, manufacturing and a host of diversified industries. Key competitive differentiators for GBS include its global scale, solution objectivity, depth of industry expertise, strong partnerships, vendor and product independence and end-to-end solutions and capabilities. Changing business issues such as globalization, fast-developing economies, government regulation, and growing concerns around risk, security, and compliance drive demand for these GBS offerings.

Global Infrastructure Services (GIS) - GIS provides managed and virtual desktop solutions, unified communications and collaboration services, data center management, cyber security, compute and managed storage solutions to commercial clients globally. GIS also delivers CSC's next-generation Cloud offerings, including Infrastructure as a Service (IaaS), private Cloud solutions, CloudMail and Storage as a Service (SaaS). GIS provides a rich portfolio of standard offerings that have predictable outcomes and measurable results while reducing business risk and operational costs for clients. To provide clients with uniquely differentiated offerings, GIS maintains a select number of key alliance partners to make investments in developing unique offerings and go-to market strategies. This collaboration helps CSC determine the best technology, road map and opportunities to differentiate solutions, expand market reach, augment capabilities, and jointly deliver impactful solutions. GIS seeks to capitalize on the emerging market trend and rebundled IT portfolio on virtualized infrastructure.

North American Public Sector (NPS) - NPS delivers IT, mission, and operations-related services to the Department of Defense, civil agencies of the U.S. federal government, as well as other foreign, state and local government agencies. Commensurate with the Company's strategy, NPS is leveraging our commercial best practices and next-generation technologies to bring scalable and more cost-effective IT solutions to government agencies that are seeking efficiency through innovation. This approach is designed to yield lower implementation and operational costs as well as a higher standard of delivery excellence. Demand for NPS offerings are driven by evolving government priorities such as: 1) migration to next-generation IT solutions, which includes hybrid cloud infrastructure, application modernization and orchestration, 2) mission intelligence driven by big data solutions, 3) health IT and informatics, and 4) cyber security.

To conform to the new reportable segments, CSC filed a Form 8-K on February 7, 2014 to recast prior period segment information presented in its Form 10-K for the fiscal year ended March 29, 2013. For additional information regarding our business segments, see Note 19 of the Consolidated Financial Statements.

Economic and Industry Factors

The Company's results of operations are impacted by economic conditions generally, including macroeconomic conditions. CSC monitors the macroeconomic conditions, the credit market conditions, and levels of business confidence, and assesses their potential impact on its customers' and its own business. A severe and/or prolonged economic downturn could adversely affect the financial condition and the levels of business activities in the industries and geographies in which CSC operates. This may reduce demand for CSC's services or depress pricing of those services and have a material adverse effect on its new contract bookings and results of operations. Particularly in light of recent economic uncertainty, CSC continues to monitor its costs closely in order to respond to changing conditions and to manage any impact to its results of operations.

The Company's results of operations are also affected by levels of business activity and rates of change in the industries it serves, as well as by the pace of technological change and the type and level of technology spending by its clients. The ability to identify and capitalize on these markets and technological changes early in their cycles is a key driver of CSC's performance.

Revenues are driven by the Company's ability to secure new contracts and to deliver solutions and services that add value to its clients. CSC's ability to add value to clients, and therefore generate revenues, depends in part on its ability to deliver market-leading service offerings and to deploy skilled teams of professionals quickly and on a global basis.

The GBS and GIS segment markets are affected by various economic and industry factors. The economic environment in the regions CSC serves will impact customers' decisions for discretionary spending on IT projects. CSC is in a highly competitive industry which exerts downward pressure on pricing and requires companies to continually seek ways to differentiate themselves through several factors, including service offerings and flexibility. Management monitors industry

factors including relative market shares, growth rates, billing rates, staff utilization rates and margins as well as macroeconomic indicators such as interest rates, inflation rates and foreign currency rates.

Outsourcing contracts are typically long-term relationships. Long-term, complex outsourcing contracts, including their consulting components, require ongoing review of the terms and scope of work in order to meet clients' evolving business needs and performance expectations.

More recently, the Company has rationalized its service offerings and implemented a strategy of selling defined solutions that require less customization and benefit from leveraged delivery at scale. Such solutions include our portfolio of Cloud-based Infrastructure-as-a-Service offerings, managed applications services and a range of discrete offerings for computing, storage, mobility and networking services.

The NPS segment market is also highly competitive and has unique characteristics. All U.S. federal government contracts and subcontracts may be modified, curtailed or terminated at the convenience of the federal government if program requirements or budgetary constraints change. In the event that a contract is terminated for convenience, the Company generally is reimbursed for its allowable costs through the date of termination and is paid a proportionate amount of the stipulated profit or fee attributable to the work performed. Shifting priorities of the U.S. federal government can also impact the future of projects. Management monitors government priorities and industry factors through numerous industry and government publications and forecasts, legislative activity, budgeting and appropriation processes and by participating in industry professional associations.

The U.S. federal government may terminate almost all of CSC's government contracts and subcontracts either at its convenience or for default based on factors set forth in the Federal Acquisition Regulation. Upon termination for convenience of a fixed-price type contract, our U.S. federal government contracts normally entitle us to receive the purchase price for delivered items, reimbursement for contractual commitments and allowable costs for work-in-process, and a reasonable allowance for profit, although there can also be financial impact resulting from the negotiated contract settlement. Upon termination for convenience of a U.S. federal government cost reimbursable or time and material contract, we normally are entitled to reimbursement of allowable costs plus a fee. Allowable costs generally include the cost to terminate agreements with suppliers and subcontractors. The amount of the fee recovered, if any, generally is related to the portion of the work completed prior to termination and is determined by negotiation. See Risk Factor number 19 under Item 1A "Risk Factors" in this Annual Report for further discussion.

Business Drivers

Revenue in all three lines of business is generated by providing services on a variety of contract types lasting from less than six months to ten years or more. Factors affecting revenue include the Company's ability to successfully:
bid on and win new contract awards,

satisfy existing customers and obtain add-on business and win contract recompetes,

compete on services offered, delivery models offered, technical ability and innovation, quality, flexibility, global reach, experience, and results created, and

identify and integrate acquisitions and leverage them to generate new revenues.

Earnings are impacted by the above revenue factors and, in addition, the Company's ability to:
control costs, particularly labor costs, subcontractor expenses and overhead costs including healthcare, pension and general and administrative costs,

anticipate talent needs to avoid staff shortages or excesses,

accurately estimate various factors incorporated in contract bids and proposals,

develop offshore capabilities and migrate compatible service offerings offshore, and

manage foreign currency fluctuations related to international operations.

Cash flows are affected by the above earnings factors and, in addition, by the following factors:
timely management of receivables and payables,

investment opportunities available, particularly related to business acquisitions, dispositions and large outsourcing contracts,

tax obligations, and

the ability to efficiently manage capital deployed for outsourcing contracts, software, and property, plant and equipment.

Key Performance Indicators

The Company manages and assesses the performance of its business through various means, with the primary financial measures including new contract wins, revenue, operating margins, and free cash flow.

New contract wins: In addition to being a primary driver of future revenue, new contract wins also provide management an assessment of the Company's ability to compete. The total level of wins tends to fluctuate from year to year depending on the timing of new or recompeted contracts, as well as numerous external factors.

Revenue: Revenue is a product of contracts won in prior periods, known as backlog, and work secured in the current year. Year-over-year revenues tend to vary less than new contract wins, and reflect performance on both new and existing contracts. Foreign currency fluctuations also impact revenue.

Operating margins: Operating margins reflect the Company's performance on contracts and ability to control costs. While the ratios of various cost elements as a percentage of revenue can shift as a result of changes in the mix of businesses with different cost profiles, a focus on maintaining and improving overall margins leads to improved efficiencies and profitability. Although the majority of the Company's costs are denominated in the same currency as revenues, increased use of offshore support also exposes CSC to additional margin fluctuations.

Free cash flow: Primary drivers of the Company's free cash flow are earnings provided by the Company's operations and the use of capital to generate those earnings. Also contributing to short-term cash flow results are movements in current asset and liability balances.

Fiscal 2014 Highlights

The key operating results for fiscal 2014 include:

Revenues decreased $1,197 million, or 8.4%, to $12,998 million compared to fiscal 2013. On a constant currency basis(1), revenues decreased $1,164 million or 8.2%.

Operating income(2) increased to $1,322 million as compared to $878 million in fiscal 2013. The operating income margins increased to 10.2% from 6.2% in fiscal 2013.

Earnings before interest and taxes(3) (EBIT) increased to $1,041 million as compared to $610 million in fiscal 2013. The EBIT margin increased to 8.0% from 4.3% in fiscal 2013.

Income from continuing operations before taxes was $910 million, compared to $449 million in fiscal 2013.

Income from discontinued operations, net of taxes was $69 million, compared to $481 million in fiscal 2013.

Net income attributable to CSC common shareholders was $674 million, compared to $961 million in fiscal 2013.

(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 of the Company's 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, and segment general and administrative (G&A) expense, excluding corporate G&A. 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. A reconciliation of consolidated operating (loss) income to (loss) income from continuing operations before taxes is as follows:

                                                            Twelve Months Ended
(Amounts in millions)                     March 28, 2014       March 29, 2013       March 30, 2012
Operating (loss) income                  $        1,322      $           878       $       (1,383 )
Corporate G&A                                      (263 )               (293 )               (219 )
Interest expense                                   (147 )               (183 )               (174 )
Interest Income                                      16                   22                   38
Goodwill impairment                                   -                    -               (2,745 )
Other income, net                                   (18 )                 25                   (4 )
Income (loss) from continuing
operations before taxes                  $          910      $           449       $       (4,487 )

(3) EBIT is a non-U.S. 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:

                                                               Twelve Months Ended
(Amounts in millions)                        March 28, 2014       March 29, 2013      March 30, 2012
Earnings (loss) before interest and taxes   $        1,041      $          610       $       (4,351 )
Interest expense                                      (147 )              (183 )               (174 )
Interest income                                         16                  22                   38
Taxes on income                                       (289 )                49                   96
Income (loss) from continuing operations    $          621      $          498       $       (4,391 )

Diluted earnings per share (EPS) from continuing operations was $4.01 as compared to $3.09 in the prior year.

Diluted EPS from discontinued operations was $0.46 as compared to $3.09 in the prior year.

In fiscal 2014, the Company recorded restructuring costs of $76 million, of which $46 million related to GBS, $28 million to GIS, and $2 million to NPS. In fiscal 2013, the Company recorded restructuring costs of $264 million, of which $87 million was related to GBS, $142 million to GIS, $13 million to NPS and $22 million to Corporate.

The Company announced contract awards(4)(5) of $14.5 billion, including GBS segment awards of $6.1 billion, GIS segment awards of $4.1 billion, and NPS segment awards of $4.3 billion.

Total backlog(6) at the end of fiscal 2014 was $30.1 billion, a decrease of $1.7 billion as compared to the backlog at the end of fiscal 2013 of $31.8 billion. Of the total $30.1 billion backlog, $8.2 billion is expected to be realized as revenue in fiscal 2015, and $9.5 billion is not yet funded.

Days Sales Outstanding (DSO)(7) was 73 days at March 28, 2014, an improvement from 77 days at March 29, 2013.

Debt-to-total capitalization ratio(8) was 42.3% at the end of fiscal 2014, a decrease of 4.1 percentage points from 46.4% at the end of fiscal 2013.

Cash provided by operating activities was $1,560 million, as compared to $1,119 million during fiscal 2013.

Cash used in investing activities was $566 million, as compared to cash provided of $456 million during fiscal 2013.

Cash used in financing activities was $599 million, as compared to $589 million during fiscal 2013.

Free cash flow(9) was $689 million, as compared to $264 million in fiscal 2013.

(4) The Company deployed a new global order input system at the beginning of fiscal 2014 to enhance "lead-to-order" management. This new system permits better and more comprehensive tracking of awards, and enabled the implementation of a revised methodology for reporting new bookings. Fiscal 2013 awards have been recast to be consistent for comparison purposes.

(5) Business awards for GIS are estimated at the time of contract signing based on then existing projections of service volumes and currency exchange rates, and include option years. Effective fiscal 2014, GBS' policy of tracking awards was made consistent with the existing GIS policy. 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. CSC's business awards, for all periods presented, have been recast to exclude the awards relating to businesses that have been sold.

(6) 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. CSC's backlog, for all periods presented, have been recast to exclude the backlog relating to discontinued operations.

(7) 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 tax receivables and long-term receivables.

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

(9) Free cash flow is a non-GAAP measure and the Company's definition of such measure may differ from that used by 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:

                                                              Twelve Months Ended
(Amounts in millions)                         March 28, 2014     March 29, 2013     March 30, 2012
Net cash provided by operating activities    $       1,560      $       1,119      $       1,176
Net cash (used in) provided by investing              (566 )              456             (1,308 )
Acquisitions, net of cash acquired                     190                 34                374
Business dispositions                                 (248 )           (1,108 )               (2 )
Short-term investments                                  (5 )                -                 (4 )
Payments on capital leases and other                  (242 )             (237 )             (177 )
long-term asset financings
Free cash flow                               $         689      $         264      $          59

Results of Operations


Revenues for the GBS, GIS, and NPS segments for fiscal 2014, 2013, and 2012 are
as follows:
                                              Twelve Months Ended
                           March 28, 2014          March 29, 2013        March 30, 2012
                                     Percent                 Percent
(Amounts in millions)     Amount      Change      Amount      Change         Amount
GBS                     $  4,414     (10.2 )%   $  4,917       0.8  %   $        4,877
GIS                        4,613      (2.7 )       4,743      (2.0 )             4,840
NPS                        4,099     (12.1 )       4,662      (4.5 )             4,880
Corporate                     12                      13                            13
Subtotal                  13,138      (8.4 )      14,335      (1.9 )            14,610
Eliminations                (140 )                  (140 )                        (134 )
Total Revenue           $ 12,998      (8.4 )%   $ 14,195      (1.9 )%   $       14,476

The major factors affecting the percent change in revenues are presented as follows:

                                                          Impact of
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