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 Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. 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, management's assessment of estimates related to profitability of its long-term contracts and estimates related to impairment of contract-specific assets, 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 the Company's Annual Report on Form 10-K, for the year ended
March 28, 2014. 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.
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 unaudited Consolidated Condensed Financial Statements and notes thereto included herein and the Company's Annual Report on Form 10-K for the fiscal year ended March 28, 2014. The following discusses the Company's financial condition and results of operations as of and for the first three months of July 4, 2014, and the comparable period of the prior fiscal year.
CSC is a global leader of information technology (IT) and professional services and solutions. The Company's mission is to enable superior returns on its clients' technology investments through best-in-class industry solutions, domain expertise and global scale.
The Company's reportable segments are as follows:
• Global Business Services (GBS) - GBS provides end-to-end applications
services; consulting; and industry-aligned software and solutions to
enterprise clients around the world. GBS manages and industrializes clients'
application ecosystem through its Applications Services offering. The company
has formed a number of strategic partnerships with leading technology
companies such as HCL Technologies and SAP to deliver world-class solutions
to its customers . These partnerships will enable clients to modernize and
move enterprise workloads to next generation cloud infrastructure, while
leveraging the benefits of mobility, social networking and big data. The GBS
consulting business assists clients in achieving greater value from current
IT assets as well as aiding in the direction of future IT investments. GBS
software and solutions include vertically-aligned solutions and process-based
intellectual property. Clients include major global enterprises in the
insurance, banking, healthcare, life sciences, manufacturing and a host of
diversified industries. Key competitive differentiators for GBS include its
global scale, depth of industry expertise, strong partnerships with leading
technology companies, vendor and product independence and end-to-end 39
-------------------------------------------------------------------------------- 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 next-generation hybrid Cloud
infrastructure solutions to clients. The company integrates public cloud
offerings from Amazon Web Services, Microsoft, and VMware, with its
industry-leading private cloud solution, BizCloud. The CSC Agility Platform
enables enterprises to manage, monitor, and automate applications over
heterogeneous and hybrid clouds. The GIS portfolio of standard offerings
delivers measurable results while reducing business risk and operational
costs for clients. Collaboration with key alliance partners helps CSC to
determine the best technology road map for clients and opportunities to differentiate solutions, expand market reach, augment capabilities, and jointly deliver impactful solutions.
• North American Public Sector (NPS) - NPS delivers IT, mission, and
operations-related services to the
the U.S. federal government, as well as other foreign, state and local
government agencies. Commensurate with the Company's strategy of leading the
next generation of IT services, NPS is leveraging our commercial best practices and next-generation offerings to bring more cost-effective IT solutions to government agencies which 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. 40
The key operating results for the first quarter of fiscal 2015 include:
• Revenues for the first quarter of fiscal 2015 were
• Operating income(2) for the first quarter of fiscal 2015 was
quarter fiscal 2015 operating income margin was 9.4% compared to 10.2% for
the same period of prior year. • Earnings before interest and taxes(3) (EBIT) for the first quarter of fiscal 2015 was
$248 millioncompared to $269 millionfor the first
quarter of fiscal 2014. EBIT margin was 7.7% compared to 8.3% in the prior
• Income from continuing operations before taxes was
first quarter of fiscal 2015, as compared to
$234 millionin the first quarter of fiscal 2014.
• (Loss) income from discontinued operations, net of taxes, was
for the first quarter of fiscal 2015, as compared to
$16 millionin the same period of fiscal 2014. (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 Principles
(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 that used by other companies. CSC defines 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 and mark-to-market adjustment to pension expense.
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 from continuing operations before taxes,
which includes costs excluded from the operating income definition such as
corporate G&A, mark-to-market adjustment to pension expense, interest and
other income (expense). A reconciliation of consolidated operating income
to income from continuing operations before taxes is as follows:
Quarter Ended (Amounts in millions) July 4, 2014 June 28, 2013 Operating income
$ 304 $ 332Corporate G&A (56 ) (64 ) Pension net actuarial gains (losses) (1 ) - Interest expense (39 ) (39 ) Interest income 5 4 Other income, net 1 1 Income from continuing operations before taxes $ 214 $ 234(3) Earnings before interest and taxes (EBIT) is a non-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 that used by other companies. CSC defines EBIT as
revenue less costs of services, selling, general and administrative expenses, depreciation and amortization, restructuring costs, and other income (expense). EBIT margin is defined as EBIT as a percentage of revenue. A reconciliation of EBIT to income from continuing operations is as follows: Quarter Ended (Amounts in millions) July 4, 2014 June 28, 2013
Earnings before interest and taxes
(39 ) (39 ) Interest income 5 4 Taxes on income (55 ) (73 )
Income from continuing operations
• Net income attributable to CSC common stockholders was
$174 millionin the prior year.
• Diluted earnings (loss) per share (EPS) for the first quarter of fiscal
$0.98, a decrease of $0.16as compared to $1.14for the same period in the prior fiscal year. Diluted EPS was comprised of $1.03from continuing operations and $(0.05)from discontinued operations, as compared to $1.03and $0.11, respectively, for the same period in the prior fiscal year. • The Company announced total contract awards(4) of $2.7 billionfor the
first quarter of fiscal 2015, including
for GIS and
$0.3 billionfor NPS.
• Days Sales Outstanding (DSO)(5) was 81 days at
from 77 days at the end of the first quarter of the prior fiscal year. • Net debt-to-total capitalization ratio(6) was 6.3% at
July 4, 2014, a
decrease of 0.2% percentage points from 6.3% at
March 28, 2014.
• Cash provided by operating activities was
months of fiscal 2015, as compared to
used in investing activities was
of fiscal 2015, as compared to cash provided of
year. Cash used in financing activities was
three months of fiscal 2015, as compared to
$207 millionprovided in the prior year.
• Free cash flow(7) of
months of fiscal 2014. (4) Business awards for GBS & 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. 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.
(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) Net debt-to-total capitalization ratio is defined as total current and long-term debt less total cash and cash equivalents 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. CSC defines 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) July 4, 2014 June 28, 2013 Net cash provided by operating $ 273
Net cash (used in) provided by investing activities (114 ) (101 ) Business dispositions (5 ) (56 ) Short-term investments - (5 ) Payments on capital leases and other (84 ) (60 ) long-term asset financings Free cash flow $ 70 $ (9 ) 42
Results of Operations
Results of operations for the first quarter of fiscal 2015 were impacted by the following events:
• During the first quarter of fiscal 2015, the Company changed its accounting
policy for the recognition of actuarial gains and losses for its defined
benefit pension and other post-retirement benefit plans and the calculation
of expected return on pension plan assets. Historically, the Company
recognized actuarial gains and losses in excess of 10% of the greater of the
market-related value of plan assets or the plans' projected benefit
obligations (the "corridor") as a component of accumulated other
comprehensive loss in its Consolidated Condensed Balance Sheets and,
depending on the benefit plan, the Company amortized these gains and losses
to earnings either over the remaining average service period for the active
participants or over the average remaining life expectancy of the inactive
participants. Additionally, for the Company's U.S. plans and the Australian
plan, the Company previously used a calculated value for the market-related
valuation of pension plan assets, reflecting changes in the fair value of
plan assets over a three-year and a one-year period, respectively. Under the
Company's new accounting policies, the Company recognizes changes in
actuarial gains and losses and the changes in fair value of plan assets in
earnings at the time of plan remeasurement, typically annually during the
fourth quarter of each year as a component of net periodic benefit expense
(and the Company no longer applies a corridor and, therefore, no longer
defers any gains or losses). The new accounting policies result in the
changes in actuarial gains and losses and the changes in fair value of plan
assets being recognized in earnings in the year they occur, rather than
amortized over time, and therefore recognized earlier than under the
Company's previous methods of accounting. The Company believes the new
pension accounting policies are preferable as they recognize the effects of
plan investment performance, interest rate changes, changes in actuarial
assumptions as a component of earnings in the year in which they occur rather
than amortized over time, and additionally, conform all plans to a consistent
policy for determining market-related value of plan assets. These changes
have been reported through retrospective application of the new accounting
methods to all periods presented. The remaining components of
pension/postretirement expense, primarily current period service and interest
costs and expected return on plan assets, will continue to be recorded on a
quarterly basis. In addition to the above mentioned accounting policy changes, the Company also changed the way in which it allocates the elements of net periodic pension (benefit) cost to its reportable segments to be aligned with changes in how the Company's chief operating decision maker evaluates segment performance. Historically, total net periodic pension (benefit) cost, including the amortization of deferred actuarial losses/(gains) and changes in fair value of plan assets were reported within operating income, as defined by the Company, and fully allocated to reportable segments. Under the new allocation approach, the net actuarial gains and losses component of the net periodic pension (benefit) cost (mark-to-market adjustments) are excluded entirely from the Company's definition of operating income and not allocated to the reportable segments. All of the other elements of net periodic pension (benefit) cost, excluding mark-to-market adjustments, will continue to be included within operating income of the Company's reportable segments. The Company has applied the change in the allocation approach retrospectively, adjusting segment reporting for all prior periods presented (see Note 15 to the unaudited Consolidated Condensed Financial Statements).
For the impact of change in the pension accounting method, see Note 2 to the unaudited Consolidated Condensed Financial Statements.
• The Company reports its results based on a fiscal year convention that
comprises four thirteen-week quarters. Every fifth year includes an
additional week in the first quarter of the fiscal year to prevent the fiscal
year from moving from an approximate end of March date. As a result, the
first quarter of fiscal 2015 had an extra week. For the additional week, the
revenue impact consisted of two components. The first component of
million represents the amortization of fixed fee contracts, primarily in the
GIS segment. This amount will normalize in subsequent quarters and will have
no impact on total revenue for the fiscal year. The second is a variable
component, which represents volume-based revenue and is influenced by several
factors such as business mix, timing of vacations and number of holidays in
the period. The variable revenue component is difficult to estimate and
ranges from a very low amount to approximately
to full year results. Despite the variable component of extra-week revenue,
CSC's costs during the extra week were largely fixed. At the upper end of the
revenue range, CSC believes that cost ratios and operating margin on the
incremental revenue would not be dissimilar to CSC's overall business.
However, at lower levels of incremental revenue, cost ratios may have been
higher and operating margin lower than CSC's overall business. 43
• Effective fiscal 2015, the Company changed its inter-company accounting
policy. Previously, inter-company transactions between segments were
generally reflected as inter-company revenue. Under the new policy,
inter-company transactions are now generally treated as cost transfers. The
new inter-company policy has been applied retrospectively, adjusting the
segment results for all prior periods. See Note 15 of the unaudited Consolidated Condensed Financial Statements.
Revenues for the GBS, GIS and NPS segments for the quarters ended
Quarter Ended Percent (Amounts in millions) July 4, 2014 June 28, 2013 Change Change GBS
$ 1,088$ 1,054 $ 343.2 % GIS 1,131 1,147 (16 ) (1.4 ) NPS 1,018 1,053 (35 ) (3.3 ) Corporate - - - - Subtotal 3,237 3,254 (17 ) (0.5 ) Eliminations - - - - Total Revenue $ 3,237$ 3,254 $ (17 )(0.5 )%
The major factors affecting the percent change in revenues for the quarter ended
Quarter Ended Approximate Impact of Currency Net Internal Acquisitions Fluctuations Growth Total GBS 0.1 % 2.3 % 0.8 % 3.2 % GIS 0.3 1.8 (3.5 ) (1.4 ) NPS - - (3.3 ) (3.3 ) Cumulative Net Percentage 0.1 % 1.4 %
(2.0 )% (0.5 )%
Global Business Services
GBS segment revenue for the first quarter of fiscal 2015 of
$1,088 million, increased $34 millionor 3.2%, compared to the same period of fiscal 2014. In constant currency, revenue increased $9 millionor 0.9%. The favorable foreign currency impact was primarily due to movement in the U.S. dollar against the British pound and the euro. The revenue increases, in constant currency, for the first quarter were primarily attributable to higher software license revenue, an adverse fiscal 2014 revenue adjustments of $19 millionthat did not recur in fiscal 2015. These revenue increases were partially offset by a decline in GBS consulting business.
GBS had contract awards of
Global Infrastructure Services
GIS segment revenues for the first quarter of fiscal 2015 decreased
$16 millionor 1.4%, compared to the same period of fiscal 2014. In constant currency, GIS revenue decreased $37 millionor 3.2%. The favorable foreign currency impact was primarily due to movement in the U.S. dollar against the British pound and the euro. The decrease in GIS' revenue at constant currency for the first quarter was a result of net reduced revenue of $17 millionfrom contracts that terminated or concluded, and reduced revenue of $76 milliondue to price-downs and contract modifications. These decreases were partially offset by increased revenue of $56 millionfrom new and existing contracts. 44 --------------------------------------------------------------------------------
GIS had contract awards of
North American Public Sector
NPS segment revenues were derived from the following sources:
Quarter Ended Percent (Amounts in millions) July 4, 2014 June 28, 2013 Change Change Department of Defense $ 562 $ 595
$ (33 )(5.5 )% Civil Agencies 373 405 (32 ) (7.9 ) Other (1) 83 53 30 56.6 Total $ 1,018$ 1,053 $ (35 )(3.3 )%
(1) Other revenues consist of foreign, state and local government work as well as commercial contracts performed by the NPS segment.
NPS revenue of
$1,018 millionfor the first quarter of fiscal 2015 decreased $35 millionor 3.3%, compared to the same period of fiscal 2014. The year-over-year NPS revenue decrease was due to lower revenue on both Department of Defense(DOD) and Civil Agencies(Civil) contracts. These decreases were partially offset by a revenue increase from non-federal government contracts. The decrease in revenue from DODcontracts, included $14 millionof reduced revenue on certain contracts that either had concluded or were winding down, and $20 millionof reduced revenue attributable to a net reduction in tasking on existing contracts. The decrease in revenue from Civil contracts included $18 milliondue to reduced scope and tasking on existing contracts, and reduced revenue of $20 milliondue to programs winding down or ending. These revenue decreases were partially offset by net favorable adjustments of $5 millionon contracts accounted for under the percentage-of-completion method.
Increased revenue on contracts with non-federal agencies was primarily due to revenue recognition of
NPS had contract awards of
$0.3 billionduring the first quarter of fiscal 2015, as compared to $0.7 billion, during the comparable period in the prior year. The Company expects the trend of reduced contract scopes, including reduced tasking to continue in the near term.
Costs and Expenses
The Company's total costs and expenses were as follows:
Quarter Ended Amount Percentage of Revenue Percentage (Amounts in millions) July 4, 2014 June 28, 2013 July 4, 2014 June 28, 2013 of Revenue Change Costs of services (excludes depreciation & amortization and restructuring costs)
$ 2,364 $ 2,43773.0 % 74.8 % (1.8 )% Selling, general and administrative 344 288 10.6 8.9 1.7 Depreciation and amortization 272 254 8.4 7.8 0.6 Restructuring costs 10 7 0.3 0.2 0.1 Interest expense, net 34 35 1.1 1.1 - Other income, net (1 ) (1 ) - - - Total $ 3,023 $ 3,02093.4 % 92.8 % 0.6 % 45
Costs of Services
Costs of services (COS), excluding depreciation and amortization and restructuring charges, as a percentage of revenue decreased 1.8 percentage points for the first quarter of fiscal 2015 compared to same period of the prior fiscal year.
The overall decrease in the COS ratio was driven by decreases in all three segments. The GBS COS ratio decreased mainly due to higher year-over-year revenues. The GIS COS ratio benefited by
$24 milliondue to a gain from the sale of certain intangible assets. The NPS COS ratio benefited from favorable year-over-year adjustments on contracts accounted for under the percentage-of completion method. These adjustments included a net $9 millionfavorable revenue impact and a net $6 millionfavorable cost impact. In addition, the COS ratio for all segments benefited from lower year-over-year headcount resulting from management's restructuring efforts that were directed to align resources to support business needs, lower incentive compensation expense, and a greater year-over-year pension benefit.
Selling, General and Administrative
Selling, general and administrative (SG&A) expense, excluding restructuring charges, as a percentage of revenue increased 1.7 percentage points for the first quarter of fiscal 2015. The higher SG&A ratio was primarily driven by higher GBS and GIS ratios, partially offset by decrease in the corporate ratio. The NPS ratio was mostly flat.
The higher GBS and GIS ratios primarily resulted from management's efforts to expand market coverage through a larger dedicated global commercial sales force consistent with the overall business strategy surrounding next-generation IT services. Per this business strategy, certain account-focused executives, who were previously engaged in the contract delivery activities, and were included within COS, in the first quarter of fiscal 2014, were redirected to focus on sales activities effective the second quarter of fiscal 2014. In addition, the Company made new investments in its commercial sales force by making incremental hires of offering sales personnel. The Company also had increased spending on bid and proposal activity during the first quarter of fiscal 2015, as compared to the same period in the prior year. The increased sales costs were partially offset by lower pension costs. Corporate G&A for the first quarter of fiscal 2015 was
$56 million, as compared to $64 millionduring the same period of the prior fiscal year. The decrease in corporate G&A expenses was mainly driven by lower outside professional services of $8 million, lower legal expenses of $3 million, partially offset by $5 millionof higher costs associated with the Company's financial transformation project.
Depreciation and Amortization
Depreciation and amortization (D&A) as a percentage of revenue increased 0.6 percentage points for the first quarter fiscal 2015 as compared to the same period of fiscal 2014. The increase in the ratio was entirely driven by the higher GIS ratio, whereas the GBS ratio declined slightly and the NPS ratio was flat, year-over-year.
The GIS ratio increased mostly due to higher amortization related to the intangible assets acquired through the
Restructuring Costs Total restructuring costs recorded during the first quarter ended
July 4, 2014were $10 million, as compared to $7 millionin the comparable period of the prior fiscal year. Restructuring costs for the first quarters of fiscal 2015 and 2014 included $1 millionand $1 million, respectively, for pension benefit augmentation. These amounts are owed to certain employees in accordance with legal or contractual obligations and will be paid out over several years as part of normal pension distributions. The fiscal 2015 first quarter restructuring expense included costs related to further reduce headcount in order to align resources to support business needs in the U.S., Australiaand in the U.K.Additional restructuring actions may be taken during fiscal 2015, which could result in additional charges (see Note 17 to the Consolidated Condensed Financial Statements). 46 --------------------------------------------------------------------------------
Interest Expense and Interest Income
There was no significant year-over-year change in interest expense and interest income. Interest expense was
$39 millionfor the first quarter of both fiscal 2015 and fiscal 2014. Interest income was $5 millionand $4 million, for the first quarter of fiscal 2015 and first quarter of fiscal 2014, respectively.
Other (Income) Expense, Net
Other (income) expense, net comprises gains and losses due to the impact of movement in foreign currency exchange rates on the Company's foreign currency denominated assets and liabilities and the related economic hedges, equity in earnings of unconsolidated affiliates, and other miscellaneous gains and losses from the sale of non-operating assets. Other income for the first quarter of both fiscal 2015 and fiscal 2014 was
$1 million. Other income for both the fiscal year periods resulted mainly due to favorable movement in foreign currency exchange rates.
The Company's effective tax rate from continuing operations (ETR) was 25.7% and 31.2% for the first quarter ended
July 4, 2014and June 28, 2013, respectively. The ETR for the first quarter ended July 4, 2014reflected the global mix of income and the change in valuation allowance in a non-U.S. jurisdiction, which decreased the ETR by 7.5%.The primary driver of the ETR for the first quarter ended June 28, 2013was the change in valuation allowance in non-U.S. jurisdictions and the global mix of income. For the tax impact of discontinued operations, see Note 4 to the Consolidated Condensed Financial Statements. There were no material changes to uncertain tax positions in the first quarter of fiscal 2015 compared to the fiscal 2014 year-end. The IRSis examining the Company's federal income tax returns for fiscal years 2008 through 2010. The Company expects to reach a resolution no earlier than fiscal year 2016. The significant items subject to examination primarily relate to foreign exchange losses and other U.S. international tax issues. In addition, the Company may settle certain other tax examinations, have lapses in statutes of limitations, or voluntarily settle income tax positions in negotiated settlements for different amounts than the Company has accrued as uncertain tax positions. The Company may need to accrue and ultimately pay additional amounts for tax positions that previously met a more likely than not standard if such positions are not upheld. Conversely, the Company could settle positions with the tax authorities for amounts lower than those that have been accrued or extinguish a position through payment. The Company believes the outcomes which are reasonably possible within the next twelve months may result in a reduction in the liability for uncertain tax positions of up to $22 million, excluding interest, penalties, and tax carryforwards. Significant management judgment is required in determining the Company's provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against deferred tax assets. A valuation allowance has been recorded against certain deferred tax assets due to uncertainties related to the ability to utilize these assets. The valuation allowance is based on historical earnings, estimates of taxable income by jurisdiction and the period over which the deferred tax assets will be recoverable. Valuation allowances are evaluated periodically and will be subject to change in each future reporting period as a result of changes in various factors. Based on recent earnings in certain jurisdictions there is a reasonable possibility that, within fiscal 2015, sufficient positive evidence may become available to reach a conclusion that a portion of the valuation allowance will no longer be needed. As such, the Company may release a significant portion of its valuation allowance against its deferred tax assets within the next nine months. This release would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period such release is recorded. Any such adjustment could materially impact the Company's financial position and results of operations. In May 2013, Finance Bill 2013 received the assent of the President of Indiaand has been enacted as the 2013 Finance Act. There are various provisions in the 2013 Finance Act that may impact our Indiaoperations, including a tax on the buy-back of shares and an increase in the dividend distribution tax from 16.22% to 16.99%. The Company uses the lower undistributed tax rate to measure deferred taxes on inside basis differences, including undistributed earnings, of our Indiaoperations as these earnings are permanently reinvested. While the Company has no plans to do so, events may occur in the future that could effectively force management to change its intent not to repatriate our Indiaearnings. If the Company changes its intent and repatriates such earnings, a dividend distribution tax will be incurred for distributions from India. These additional taxes will be recorded as tax expense in the period in which the dividend is declared. 47 -------------------------------------------------------------------------------- The Finance Act of 2012 (the 2012 Finance Act) was signed into law in Indiaon May 28th, 2012. The Act provides for the taxation of indirect foreign investment in India, including on a retroactive basis. The 2012 Finance Act overrides the Vodafone NLruling by the Supreme Court of Indiawhich held that the Indian Tax Authorities cannot assess capital gains taxes on the sale of shares of non-Indian companies that indirectly own shares in an Indian company. The retroactive nature of these changes in law has been strongly criticized. The 2012 Finance Act has been challenged in the Indian courts. However, there is no assurance that such challenge will be successful. CSC has engaged in the purchase of shares of foreign companies that indirectly own shares of an Indian company and internal reorganizations. The Indian tax authorities may seek to apply the provisions of the 2012 Finance Act to these prior transactions and seek to tax CSC directly or as a withholding agent or representative assessee of the sellers involved in prior acquisitions. The Company believes that the 2012 Finance Act does not apply to these prior acquisitions and that it has strong defenses against any claims that might be raised by the Indian tax authorities.
Income from Discontinued Operations
The income from discontinued operations represents the results of certain businesses, which have been either divested during fiscal 2014 or are held-for-sale, and gains and loss from businesses divested (see Note 4 to the Consolidated Condensed Financial Statements).
The (loss) income from discontinued operations, net of taxes, was
$(8) millionfor the quarter ended July 4, 2014, as compared to $16 millionfor the quarter ended June 28, 2013, primarily due to the gain on sale of the Flood BPO business during the first quarter of fiscal 2014, which did not recur in fiscal 2015. The loss during the first quarter of fiscal 2015 is from the small software business in Europe, which is held for sale at July 4, 2014. Subsequent to the first quarter, this business was sold.
Earnings Per Share and Share Base
Earnings per share (EPS) for the first quarter of fiscal 2015, on a diluted basis, was
$0.98, a decrease of $0.16compared to the first quarter of fiscal 2014. The decrease in EPS was the result of a decrease in income from discontinued operations, net of taxes of $24 millionfor the three months ended July 4, 2014. The decrease in income from discontinued operations was primarily due to the gain on disposition, net of taxes of $12 millionrecorded in the first quarter of fiscal 2014, that did not repeat in fiscal 2015, and a decrease of $13 millionin net loss from discontinued operations, net of taxes for the first quarter of fiscal 2015 compared to the comparable period in fiscal 2014.
Investigations and Out of Period Adjustments
Summary of Audit Committee and SEC Investigations Related to the Out of Period Adjustments
As previously disclosed, the Company initiated an investigation into out of period adjustments resulting from certain accounting errors in its former Managed Services Sector (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 Enforcementthat it had commenced a formal civil investigation relating to these matters, which investigation has 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 Enforcementas well as matters under investigation by the Audit Committee, as further described below. The Company is cooperating in the SEC'sinvestigation. On May 2, 2011, the Audit Committee commenced an independent investigation into the matters relating to the former 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 with 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 have resigned. The Audit Committee determined in August 2012that its independent investigation was complete. The Audit Committee instructed its independent counsel to cooperate with the SEC's Division of Enforcementby completing production of documents and providing any further information requested by the SEC's Division of Enforcement. In addition to the matters noted above, the SEC's Division of Enforcementis continuing its investigation involving its concerns with certain of the Company's prior disclosures and accounting determinations with respect to the Company's contract with the NHS and the possible impact of such matters on the Company's financial statements for years prior to the Company's current fiscal year. The Company and the Audit Committee and its independent counsel are continuing to respond to SECquestions and to cooperate with the SEC's Division of Enforcementin its investigation of prior disclosures and accounting determinations with respect to the Company's contract with the NHS. The SEC'sinvestigative activities are ongoing. In addition, the SEC's Division of Corporation Financehas issued comment letters to the Company requesting, among other things, additional information regarding its previously disclosed adjustments in connection with the above-referenced accounting errors, the Company's conclusions relating to the materiality of such adjustments, and the Company's analysis of the effectiveness of its disclosure controls and procedures and its internal control over financial reporting. The SEC's Division of Corporation Finance'scomment letter process is ongoing, and the Company is continuing to cooperate with that process. The investigation being conducted by the SEC's Division of Enforcementand the review of the Company's financial disclosures by the SEC's Division of Corporation Financeare continuing and could identify other accounting errors, irregularities or other areas of review. As a result, we have incurred and may continue to incur significant legal and accounting expenditures. As the Company previously disclosed, certain of its non-U.S. employees and certain of its former employees, including certain former executives in the United States, have received Wells notices from the SEC's Division of Enforcementin connection with its ongoing investigation of the Company. The Company received a Wells notice from the SEC's Division of Enforcementon December 11, 2013. A Wells notice is not a formal allegation or a finding of wrongdoing; it is a preliminary determination by the SEC Enforcement Staff to recommend that the Commission file a civil enforcement action or administrative proceeding against the recipient. Under SECprocedures, a recipient of a Wells notice has an opportunity to respond in the form of a Wells submission that seeks to persuade the Commission that such an action should not be brought. The Company has been availing itself of the Wells process by making a Wells submission to explain its views concerning such matters, which are aided by the Audit Committee's independent investigation and certain expert opinions of outside professionals. The Company made such a submission on January 14, 2014and a supplemental submission on April 9, 2014. The Company, through outside counsel, has been in continuing discussions with the SEC Enforcement Staff concerning a potential resolution of the staff's investigation involving the Company. However, to date those discussions have not resulted in a resolution. The Company is unable to estimate with confidence or certainty how long the SECprocess will last or its ultimate outcome, including whether the Company will reach a settlement with the SECand, if so, the amount of any related monetary fine and other possible remedies. In addition, the Company is unable to predict the timing of the completion of the SEC's Division of Corporation Finance'sreview of its financial disclosures or the outcome of such review. Publicity surrounding the foregoing or any enforcement action as a result of the SEC'sinvestigation, even if ultimately resolved favorably for CSC, could have an adverse impact on the Company's reputation, business, financial condition, results of operations or cash flows. 48 --------------------------------------------------------------------------------
Out of Period Adjustments Financial Impact Summary
The rollover impact on the pre-tax income (loss) from continuing operations of the recorded out of period adjustments in the first quarter of fiscal 2015, fiscal 2014 and fiscal 2013 is attributable to the following prior fiscal years:
First Quarter Fiscal (Amounts in millions) Fiscal 2013 Adjustments Fiscal 2014 Adjustments 2015 Adjustments Total Adjustments Fiscal 2015 $ - $ - $ (12 ) $ (12 ) Fiscal 2014 - (2 ) 13 11 Fiscal 2013 6 4 (1 ) 9 Prior fiscal years (unaudited) (6 ) (2 ) - (8 )
See Note 15 for a summary of the effect of the pre-tax out of period adjustments on the Company's segment results for the quarters ended
Fiscal 2015 Adjustments
During the first quarter of fiscal 2015, the Company identified and recoded net adjustments increasing pre-tax income from continuing operations by
$12 millionthat should have been recorded in prior fiscal years. The net impact of these adjustments on income from continuing operations before taxes for the first quarter ended fiscal 2015 primarily included lower fiscal 2014 variable compensation partially offset by certain adjustments related to cost of services that were identified late in the 2014 close process and, therefore, were not included in the Company's fiscal 2014 Consolidated Financial Statements. Adjustments recorded during the first quarter of fiscal 2015 that should have been recorded in prior fiscal years, increased net income attributable to CSC common shareholders by $2 million. The impact of out of period adjustments recorded during fiscal 2015 on select line items of the unaudited Consolidated Condensed Statements of Operations for the quarter ended July 4, 2014, using the rollover method, is shown below: Quarter Ended
Adjustments Amount Adjusted (Amounts in millions, except per-share Increase/ for Removal amounts) As Reported (Decrease) of Errors Revenue
$ 3,237$ 7 $ 3,244 Costs of services (excludes depreciation and amortization and restructuring costs) 2,364 20 2,384 Selling, general and administrative 344 - 344 Depreciation and amortization 272 (1 ) 271 Restructuring costs 10 - 10 Interest expense 39 - 39 Interest income (5 ) - (5 ) Other (income) expense (1 ) - (1 ) Income from continuing operations before taxes 214 (12 ) 202 Taxes on income 55 (6 ) 49 Income from continuing operations 159 (6 ) 153 Loss from discontinued operations, net of taxes (8 ) 4 (4 ) Net income attributable to CSC common stockholders 146 (2 ) 144 EPS - Diluted Continuing operations $ 1.03 $ (0.04 )$ 0.99 Discontinued operations (0.05 ) 0.03 (0.02 ) Total $ 0.98 $ (0.01 )$ 0.97 49
-------------------------------------------------------------------------------- The out of period adjustments impacting income from continuing operations before taxes recorded by the Company in the quarter ended
July 4, 2014are related to the following line items of the unaudited Consolidated Balance Sheet: (Amounts in million) Increase/(Decrease) July 4, 2014 Accounts receivable Increase $ 5 Software Decrease 1 Other assets Decrease 3 Accrued expenses and other current liabilities Decrease 13 Deferred revenue Increase 2 The Company has determined that the impact of the consolidated out of period adjustments recorded in the first quarter of fiscal 2015 is immaterial to the consolidated results, financial position and cash flows for the current quarter and prior periods. Consequently, the cumulative effect of these adjustments was recorded during fiscal 2015. Fiscal 2014 Adjustments During the first quarter of fiscal 2014, the Company identified and recorded net pre-tax adjustments increasing income from continuing operations before taxes by $9 millionthat should have been recorded in prior fiscal years. This net impact on income from continuing operations before taxes is comprised of the following:
• net adjustments decreasing income from continuing operations before taxes
$13 millionresulting primarily from revenues and costs in its GBS segment;
• net adjustments increasing income from continuing operations before taxes
GBS segment; and
• net adjustments increasing income from continuing operations before taxes
$14 millionresulting primarily from adjustments identified by the Company late in the fiscal 2013 closing process. Adjustments recorded during the first quarter of fiscal 2014 that should have been recorded in prior fiscal years decreased income from continuing operations by $2 million. The difference between the pre-tax and after tax impact is attributable to the tax effect of the adjustments described above, and $2 millionof tax expense related to net adjustments that should have been recorded in prior periods. During periods subsequent to June 28, 2013, the Company recorded out of period adjustments with a net pre-tax impact to income from continuing operations of $9 million, primarily in Corporate, that should have been recorded in the first quarter of fiscal 2014. Had such adjustments been recorded in the appropriate period, income from continuing operations before taxes for the first quarter of fiscal 2014 would have been lower by $9 million. The impact of out of period adjustments recorded during fiscal 2014, and the first quarter of fiscal 2015, on select line items of the unaudited Consolidated Condensed Statements of Operations for the quarter ended June 28, 2013, using the rollover method, is shown below: 50 -------------------------------------------------------------------------------- Quarter Ended
Adjustments Amount Adjusted (Amounts in millions, except per-share Increase/ for Removal amounts) As Reported (Decrease) of Errors Revenue
$ 3,254$ 12 $ 3,266 Costs of services (excludes depreciation and amortization and restructuring costs) 2,437 24 2,461 Selling, general and administrative 288 4 292 Depreciation and amortization 254 - 254 Restructuring costs 7 2 9 Interest expense 39 - 39 Interest income (4 ) - (4 ) Other (income) expense (1 ) - (1 ) Income from continuing operations before taxes 234 (18 ) 216 Taxes on income 73 (15 ) 58 Income from continuing operations 161 (3 ) 158 Loss from discontinued operations, net of taxes 16 (1 ) 15 Net income attributable to CSC common stockholders 174 (4 ) 170 EPS - Diluted Continuing operations $ 1.03 $ (0.02 )$ 1.01 Discontinued operations 0.11 (0.01 ) 0.10 Total $ 1.14 $ (0.03 )$ 1.11 The out of period adjustments impacting income from continuing operations before taxes recorded by the Company in the quarter ended June 28, 2013are related to the following unaudited Consolidated Balance Sheet line items: (Amounts in million) Increase/(Decrease) June 28, 2013 Accounts receivable Decrease $ 2 Prepaid expenses and other current assets Increase 10 Software Increase 4 Other assets Increase 5 Accrued payroll and related costs Decrease 6 Accrued expenses and other current liabilities Decrease 16 Deferred Revenue Increase 21
The Company determined that the impact of the consolidated out of period adjustments recorded in the first quarter of fiscal 2014 was immaterial to the consolidated results, financial position and cash flows for the quarter of fiscal 2014 and prior periods. Consequently, the cumulative effect of these adjustments was recorded during fiscal 2014.