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10-K: DXC TECHNOLOGY CO

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(EDGAR Online via COMTEX) -- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

The purpose of the MD&A is to present information that management believes is relevant to an assessment and understanding of our results of operations and cash flows for the fiscal year ended March 31, 2020, and our financial condition as of March 31, 2020. The MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and notes.

The MD&A is organized in the following sections:

Background

Results of Operations

Liquidity and Capital Resources

Off-Balance Sheet Arrangements

Contractual Obligations

Critical Accounting Policies and Estimates

The following discussion includes a comparison of our results of operations and liquidity and capital resources for fiscal 2020 and fiscal 2019. A discussion of changes in our results of operations from fiscal 2018 to fiscal 2019 may be found in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" on Form 10-K filed with the Securities and Exchange Commission on June 13, 2019.

Background

DXC Technology helps global companies run their mission critical systems and operations while modernizing IT, optimizing data architectures, and ensuring security and scalability across public, private and hybrid clouds. With decades of driving innovation, the world's largest companies trust DXC to deploy our enterprise technology stack to deliver new levels of performance, competitiveness and customer experiences.

We generate revenue by offering a wide range of information technology services and solutions primarily in North America, Europe, Asia and Australia. We operate through two segments: GBS and GIS. We market and sell our services directly to customers through our direct sales force operating out of sales offices around the world. Our customers include commercial businesses of many sizes and in many industries and public sector enterprises.

Results of Operations

The following table sets forth certain financial data for fiscal 2020 and 2019:







                                                                          Fiscal Years Ended
        (In millions, except per-share amounts)                   March 31, 2020     March 31, 2019
        Revenues                                                 $       19,577     $        20,753
        (Loss) income from continuing operations, before taxes           (5,228 )             1,515
        Income tax expense                                                  130                 288
        (Loss) income from continuing operations                         (5,358 )             1,227
        Income from discontinued operations, net of taxes                     -                  35
        Net (loss) income                                        $       (5,358 )   $         1,262
        Diluted (loss) earnings per share:
        Continuing operations                                    $       (20.76 )   $          4.35
        Discontinued operations                                               -                0.12
                                                                 $       (20.76 )   $          4.47
        


Fiscal 2020 Highlights

Fiscal 2020 financial highlights include the following:

Fiscal 2020 revenues were $19,577 million.

Fiscal 2020 loss from continuing operations and diluted EPS from continuing operations were $5,358 million and $(20.76), respectively, including the cumulative impact of certain items of $6,820 million, or $26.34 per share, reflecting restructuring costs, transaction, separation and integration-related costs, amortization of acquired intangible assets, goodwill impairment losses, gain on arbitration award, pension and other post-retirement benefit ("OPEB") actuarial and settlement gains, and a tax adjustment related to U.S. tax reform.

Our cash and cash equivalents were $3,679 million at March 31, 2020.

We generated $2,350 million of cash from operations during fiscal 2020.

We returned $950 million to shareholders in the form of common stock dividends and share repurchases during fiscal 2020.







        Revenues
                                  Fiscal Years Ended
        (in millions)     March 31, 2020      March 31, 2019      Change     Percent Change
        GBS              $          9,111    $         8,684    $    427            4.9  %
        GIS                        10,466             12,069      (1,603 )        (13.3 )%
        Total Revenues   $         19,577    $        20,753    $ (1,176 )         (5.7 )%
        


The decrease in revenues for fiscal 2020 compared with fiscal 2019 reflects the impact of price-downs, run-off, and termination of certain accounts offset by increase in revenue in fiscal 2020 due to contributions from the Luxoft acquisition. Fiscal 2020 revenues included an unfavorable foreign currency exchange rate impact of 2.2%, primarily driven by the strengthening of the U.S. dollar against the Australian Dollar, Euro, and British Pound.

During fiscal 2020 and fiscal 2019, the distribution of our revenues across geographies was as follows:

[[Image Removed: chart-e0119ab461b35fc695a.jpg]]

For a discussion of risks associated with our foreign operations, see Part I, Item 1A "Risk Factors" of this Annual Report.

As a global company, over 63% of our fiscal 2020 revenues were earned internationally. As a result, the comparison of revenues denominated in currencies other than the U.S. dollar from period to period is impacted, and we expect will continue to be impacted, by fluctuations in foreign currency exchange rates. Constant currency revenues are a non-GAAP measure calculated by translating current period activity into U.S. dollars using the comparable prior period's currency conversion rates. This information is consistent with how management views our revenues and evaluates our operating performance and trends. The table below summarizes our constant currency revenues:







                                                         Fiscal Years Ended
                                               Constant Currency                                        Percentage
        (in millions)                            March 31, 2020      March 31, 2019        Change         Change
        GBS                                    $          9,292     $         8,684     $       608        7.0%
        GIS                                              10,731              12,069          (1,338 )    (11.1)%
        Total Revenues                         $         20,023     $        20,753     $      (730 )     (3.5)%
        


Global Business Services

Our GBS segment revenues were $9.1 billion for fiscal 2020, representing an increase of $0.4 billion, or 4.9%, compared to fiscal 2019. The revenue increase included an unfavorable foreign currency exchange rate impact of $0.2 billion, or 2.1%. GBS revenues in constant currency were $9.3 billion for fiscal 2020, representing an increase of $0.6 billion, or 7.0%. The increase in GBS revenue in fiscal 2020 is due to contributions from the Luxoft acquisition which closed in June 2019.

Global Infrastructure Services

Our GIS segment revenues were $10.5 billion for fiscal 2020, representing a decrease of $1.6 billion, or 13.3%, compared to fiscal 2019. The revenue decline included an unfavorable foreign currency exchange rate impact of $0.3 billion, or 2.2%. GIS revenues in constant currency were $10.7 billion for fiscal 2020, representing a decrease of $1.3 billion, or 11.1%. The decrease in GIS revenue in fiscal 2020 reflects the impact of price-downs, run-off, and termination of certain accounts.

During fiscal 2020, GBS and GIS had contract awards of $9.0 billion and $8.7 billion, respectively, compared with $9.3 billion and $11.4 billion, respectively, during fiscal 2019.







        Costs and Expenses
        Our total costs and expenses were as follows:
                                                       Fiscal Years Ended                Percentage of Revenues
        (in millions)                          March 31, 2020      March 31, 2019         2020             2019
        Costs of services (excludes
        depreciation and amortization and
        restructuring costs)                  $        14,901     $       14,946          76.0  %           72.1  %
        Selling, general and administrative
        (excludes depreciation and
        amortization and restructuring
        costs)                                          2,050              1,959          10.5               9.4
        Depreciation and amortization                   1,942              1,968           9.9               9.5
        Goodwill impairment losses                      6,794                  -          34.7                 -
        Restructuring costs                               252                465           1.3               2.2
        Interest expense                                  383                334           2.0               1.6
        Interest income                                  (165 )             (128 )        (0.8 )            (0.6 )
        Gain on arbitration award                        (632 )                -          (3.2 )               -
        Other income, net                                (720 )             (306 )        (3.7 )            (1.5 )
        Total costs and expenses              $        24,805     $       19,238         126.7  %           92.7  %
        


The 34.0 point increase in costs and expenses as a percentage of revenue for fiscal 2020 primarily reflects our goodwill impairment losses, which were partially offset by the gain on arbitration award and other income.

Costs of Services

Cost of services, excluding depreciation and amortization and restructuring costs ("COS"), was $14.9 billion for fiscal 2020, including Luxoft, which was flat compared to fiscal 2019. COS as percentage of revenue increased 3.9 points, compared to fiscal 2019. This increase was driven by the ongoing investments we are making to secure our customers and higher cost take-out activities in the prior year.

Selling, General and Administrative

Selling, general and administrative expense, excluding depreciation and amortization and restructuring costs ("SG&A"), was $2.1 billion for fiscal 2020, as compared to $2.0 billion for fiscal 2019. SG&A increased $0.1 billion, and as a percentage of revenue increased 1.1 points, compared to fiscal 2019. The increase includes SG&A related to the Luxoft Acquisition, which we acquired during the first quarter of fiscal 2020.

Integration, separation and transaction-related costs, included in SG&A, were $318 million during fiscal 2020, as compared to $401 million during fiscal 2019.

Depreciation and Amortization

Depreciation and amortization expense ("D&A") was $1.9 billion for fiscal 2020, compared to $2.0 billion for fiscal 2019. The decrease in D&A was primarily due to a $225 million benefit, respectively, from a change in estimated useful lives of certain equipment described in Note 1 - "Summary of Significant Accounting Policies", offset by an increase in depreciation on assets placed into service, as well as increases in software amortization and amortization related to accelerated transition and transformation contract costs.

Goodwill Impairment Losses

DXC recognized goodwill impairment charges totaling $6,794 million during fiscal 2020. The impairment charges were primarily the result of a sustained decline in market capitalization during the fiscal 2020. See Note 11, "Goodwill" for additional information.

Restructuring Costs

Restructuring costs represent severance related to workforce optimization programs and expense associated with facilities and data center rationalization.

During fiscal 2020, management approved global cost savings initiatives designed to reduce operating costs by re-balancing our workforce and facilities structures. The fiscal 2020 global cost savings initiatives were designed to better align our organizational structure with our strategic initiatives and continue the integration of HPES and other acquisitions.

Total restructuring costs recorded, net of reversals, during fiscal 2020 and 2019 were $252 million and $465 million, respectively. The net amounts recorded included $10 million and $2 million of pension benefit augmentations for fiscal 2020 and 2019, respectively, owed to certain employees under legal or contractual obligations. These augmentations will be paid as part of normal pension distributions over several years.

See Note 21 - "Restructuring Costs" for additional information about our restructuring actions.

Interest Expense and Interest Income

Interest expense for fiscal 2020 was $383 million as compared to $334 million in fiscal 2019. The increase in interest expense was primarily due to an increase in borrowings and asset financing activities. See the "Capital Resources" caption below and Note 13 - "Debt" for additional information.

Interest income for fiscal 2020 was $165 million, as compared to $128 million in fiscal 2019. The year-over-year increase in interest income includes pre-award interest of $34 million and post-award interest of $2 million related to arbitration discussed below under the caption "Gain on Arbitration Award."

Gain on Arbitration Award

During the second quarter of fiscal 2020, DXC received final arbitration award proceeds of $666 million related to the HPE Enterprise Services merger completed in fiscal 2018. The arbitration award included $632 million in damages that were recorded as a gain. The remaining $34 million of the award related to pre-award interest. Dispute details are subject to confidentiality obligations.







        Other Income, Net
        Other income, net includes non-service cost components of net periodic pension
        income, movement in foreign currency exchange rates on our foreign currency
        denominated assets and liabilities and the related economic hedges, equity
        earnings of unconsolidated affiliates, gain on sale of non-operating assets and
        other miscellaneous gains and losses.
        The components of other income, net for fiscal 2020 and 2019 are as follows:
                                                                        Fiscal Years Ended
        (in millions)                                          March 31, 2020         March 31, 2019
        Non-service cost components of net periodic
        pension income                                       $           (658 )     $           (182 )
        Foreign currency (gain) loss                                      (25 )                   31
        Other gain                                                        (37 )                 (155 )
        Total                                                $           (720 )     $           (306 )
        


The $414 million increase in other income for fiscal 2020, as compared to the prior fiscal year, was due to a year-over-year increase of $476 million in non-service components of net periodic pension income and a year-over-year favorable foreign currency impact of $56 million. These increases were offset by a $118 million decrease in other gains related to sales of non-operating assets.

Taxes

Our effective tax rate ("ETR") on income (loss) from continuing operations, before taxes, for fiscal 2020 and 2019 was 2.5% and 19.0% respectively. A reconciliation of the differences between the U.S. federal statutory rate and the ETR, as well as other information about our income tax provision, is provided in Note 12 - "Income Taxes."

In fiscal 2020, the ETR was primarily impacted by:

Non-taxable gain on the arbitration award, which decreased income tax expense and decreased the ETR by $186 million and 3.6%, respectively

A change in the net valuation allowance on certain deferred tax assets, primarily in Australia, Brazil, China, Luxembourg, and Singapore, which increased income tax expense and increased the ETR by $631 million and 12.1% respectively.

An increase in Income Tax and Foreign Tax Credits, primarily relating to research and development credits recognized for prior years, which decreased income tax expense and decreased the ETR by $135 million and 2.6%, respectively.

Local losses on investments in Luxembourg that increased the foreign rate differential and decreased the ETR by $637 million and 12.2%, respectively, with an offsetting increase in the ETR due to an increase in the valuation allowance of the same amount.

In fiscal 2019, the ETR was primarily impacted by:

A change in the net valuation allowance on certain deferred tax assets, primarily in Luxembourg, Germany, Spain, UK, and Switzerland, which increased income tax expense and increased the ETR by $256 million and 16.9%, respectively.

A decrease in the transition tax liability and a change in tax accounting method for deferred revenue, which decreased income tax expense and decreased the ETR by $66 million and 4.3%, respectively.

In fiscal 2018, the ETR was primarily impacted by:

The accrual of the one-time transition tax on estimated unremitted foreign earnings, which decreased the income tax benefit and increased the ETR by $361 million and 27.7%, respectively.

The remeasurement of deferred tax assets and liabilities, which increased the income tax benefit and decreased the ETR by $338 million and 25.9%, respectively.

The IRS is examining CSC's federal income tax returns for fiscal 2008 through 2017. With respect to CSC's fiscal 2008 through 2010 federal tax returns, we previously entered into negotiations for a resolution through settlement with the IRS Office of Appeals. The IRS examined several issues for this audit that resulted in various audit adjustments. We have an agreement in principle with the IRS Office of Appeals as to some but not all of these adjustments. We have agreed to extend the statute of limitations associated with this audit through September 30, 2020.

In the first quarter of fiscal 2020, we filed for competent authority relief relating to certain legacy CSC foreign restructuring expenses deducted for the U. S. federal tax return for tax year March 31, 2013. The Company has agreed to extend the statute of limitations associated with the fiscal years 2011 through 2013 through December 31, 2020. In the second quarter of fiscal 2020, the Company received a Revenue Agent's Report with proposed adjustments to CSC's fiscal 2014 through 2017 federal returns. The Company has filed a protest for certain of these adjustments with the IRS Office of Appeals. The Company has agreed to extend the statute of limitations for the fiscal 2014 through fiscal 2016 through December 31, 2020 and for the employment tax audit of fiscal years 2015 and 2016 until January 31, 2021. The Company expects to reach a resolution for all years no earlier than the first quarter of fiscal 2022 except agreed issues related to fiscal 2008 through 2010 and fiscal 2011 through 2013 federal tax returns, which are expected to be resolved within twelve months.

In addition, we 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 we have accrued as uncertain tax positions. We 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, we could settle positions by payment with the tax authorities for amounts lower than those that have been accrued or extinguish a position through payment. We believe the outcomes that are reasonably possible within the next twelve months may result in a reduction in liability for uncertain tax positions of $25 million to $27 million, excluding interest, penalties, and tax carryforwards.

Income from Discontinued Operations

The $35 million of income from discontinued operations for the fiscal year 2019 reflects the net income generated by USPS during the first quarter of fiscal 2019.

Earnings Per Share

Diluted EPS from continuing operations for fiscal 2020 was $20.76, a decrease of $25.11 per share compared with the prior fiscal year. The EPS decrease was due to a decrease of $6,585 million in income from continuing operations.

Diluted EPS for fiscal 2020 includes $0.80 per share of restructuring costs, $0.98 per share of transaction, separation and integration-related costs, $1.73 per share of amortization of acquired intangible assets, $25.78 per share of goodwill impairment losses, $(2.43) per share of arbitration award gains, $(0.74) per share of pension and OPEB actuarial and settlement gains, and $0.13 per share of tax adjustment relating to prior restructuring charges.

Non-GAAP Financial Measures

We present non-GAAP financial measures of performance which are derived from the statements of operations of DXC. These non-GAAP financial measures include earnings before interest and taxes ("EBIT"), adjusted EBIT, non-GAAP income before income taxes, non-GAAP net income and non-GAAP EPS, constant currency revenues, net debt and net debt-to-total capitalization.

We present these non-GAAP financial measures to provide investors with meaningful supplemental financial information, in addition to the financial information presented on a GAAP basis. Non-GAAP financial measures exclude certain items from GAAP results which DXC management believes are not indicative of core operating performance. DXC management believes these non-GAAP measures allow investors to better understand the financial performance of DXC exclusive of the impacts of corporate-wide strategic decisions. DXC management believes that adjusting for these items provides investors with additional measures to evaluate the financial performance of our core business operations on a comparable basis from period to period. DXC management believes the non-GAAP measures provided are also considered important measures by financial analysts covering DXC, as equity research analysts continue to publish estimates and research notes based on our non-GAAP commentary, including our guidance around non-GAAP EPS targets.

Non-GAAP financial measures exclude certain items from GAAP results which DXC management believes are not indicative of operating performance such as the amortization of acquired intangible assets and transaction, separation and integration-related costs.

Incremental amortization of intangible assets acquired through business combinations may result in a significant difference in period over period amortization expense on a GAAP basis. We exclude amortization of certain acquired intangibles assets as these non-cash amounts are inconsistent in amount and frequency and are significantly impacted by the timing and/or size of acquisitions. Although DXC management excludes amortization of acquired intangible assets primarily customer related intangible assets, from its non-GAAP expenses, we believe that it is important for investors to understand that such intangible assets were recorded as part of purchase accounting and support revenue generation. Any future transactions may result in a change to the acquired intangible asset balances and associated amortization expense.

There are limitations to the use of the non-GAAP financial measures presented in this report. One of the limitations is that they do not reflect complete financial results. We compensate for this limitation by providing a reconciliation between our non-GAAP financial measures and the respective most directly comparable financial measure calculated and presented in accordance with GAAP. Additionally, other companies, including companies in our industry, may calculate non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes between companies.

Non-GAAP financial measures and the respective most directly comparable financial measures calculated and presented in accordance with GAAP include:







                                                        Fiscal Years Ended
        (in millions)                          March 31, 2020       March 31, 2019        Change       Percentage Change
        (Loss) income from continuing
        operations                            $        (5,228 )   $          1,515     $   (6,743 )          (445.1 )%
        Non-GAAP income from continuing
        operations                            $         1,843     $          3,063     $   (1,220 )           (39.8 )%
        Net (loss) income                     $        (5,358 )   $          1,262     $   (6,620 )          (524.6 )%
        Adjusted EBIT                         $         2,061     $          3,269     $   (1,208 )           (37.0 )%
        


Reconciliation of Non-GAAP Financial Measures

Our non-GAAP adjustments include:

Transaction, separation and integration-related costs - reflects costs related to integration planning, financing and advisory fees associated with the HPES Merger and other acquisitions and costs related to the separation of USPS and costs to execute on strategic alternatives.

Amortization of acquired intangible assets - reflects amortization of intangible assets acquired through business combinations.

Goodwill impairment losses - reflects impairment losses on goodwill.

Gain on arbitration award - reflects a gain related to the HPES merger arbitration award.

Pension and OPEB actuarial and settlement gains and losses - reflects pension and OPEB actuarial and settlement gains and losses.

Tax adjustment - Fiscal 2020 includes the impact of an adjustment to the Transition Tax and tax liabilities related to prior restructuring charges. Fiscal 2019 reflects the estimated non-recurring benefit of the Tax Cuts and Jobs Act of 2017. Fiscal 2018 reflects the application of an approximate 28% tax rate, which is within the targeted effective tax rate range for fiscal year 2018. Income tax expense of other non-GAAP adjustments is computed by applying the jurisdictional tax rate to the pre-tax adjustments on a jurisdictional basis.

A reconciliation of reported results to non-GAAP results is as follows: . . .

Jun 01, 2020

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