DXC Technology Co quarterly report, Q3 FY2018

Full document

DXC Technology Company — Form 10-Q Summary

Business context and period. This unaudited report covers the three and nine months ended December 31, 2017, DXC’s fiscal third quarter and first nine months of fiscal 2018. DXC provides global IT services through Global Business Services (GBS), Global Infrastructure Services (GIS), and U.S. Public Sector (USPS). The April 1, 2017 combination of CSC and HPE’s Enterprise Services business materially changed the company’s size and composition; reported comparisons with the prior year are therefore not directly comparable. Where available, management provides pro forma comparisons that include both businesses.

Financial performance and position

  • Quarter revenue: $6.186 billion; income before tax was $438 million, net income $779 million, and diluted EPS $2.68. The reported net income includes significant tax benefits related to U.S. tax legislation.
  • Nine-month revenue: $18.262 billion; income before tax was $1.010 billion, net income $1.217 billion, and diluted EPS $4.11.
  • Margins: Third-quarter GAAP income-before-tax margin was approximately 7.1% and net margin approximately 12.6%. The net margin is substantially affected by the tax benefit; it should not be read as a recurring operating margin. Segment profit was $1.004 billion for the quarter, about 16.2% of revenue, before corporate and other reconciling items.
  • Pro forma revenue trend: Versus the comparable prior-year pro forma period, revenue declined 6.1% in the quarter and 5.7% over nine months. On a constant-currency basis, declines were 7.9% and 5.9%, respectively. Management attributed weakness mainly to contracts ending or renewing at lower rates; the USPS quarterly comparison was also affected by a prior-year one-time contract reset.
  • Non-GAAP results: Adjusted EBIT was $927 million for the quarter, versus $626 million pro forma, and $2.482 billion for nine months, versus $1.316 billion pro forma. Non-GAAP diluted EPS was $2.15 for the quarter and $5.66 for nine months. These measures exclude specified items and are not GAAP results.
  • Cash flow: Nine-month operating cash flow was $2.542 billion. Investing activities provided $213 million, including $974 million of cash acquired in the merger; financing activities used $1.136 billion. Cash increased $1.663 billion to $2.926 billion, so the increase was not solely generated by operations.
  • Debt and liquidity: Total debt was $8.540 billion and cash was $2.926 billion, for reported net debt of $5.614 billion. Total liquidity was $6.405 billion, including $3.422 billion available under the revolving credit facility. Management expected cash and operating cash generation to cover normal operating needs for the next 12 months. The company reported compliance with debt covenants.
  • Balance sheet: Total assets were $33.582 billion and total equity $13.202 billion at December 31, 2017. Current assets of $9.521 billion were below current liabilities of $9.638 billion.

Material changes versus comparable periods

  • The merger drove most of the large increases in reported revenue, assets, debt, depreciation, amortization, and interest expense; reported year-over-year growth is not an organic comparison.
  • Pro forma revenue declined across all three segments in the quarter: GBS 4.8%, GIS 5.5%, and USPS 12.1%. Nine-month pro forma declines were 4.9%, 6.6%, and 4.3%, respectively.
  • Restructuring costs rose to $213 million for the quarter and $595 million for nine months, versus $3 million and $85 million in the respective prior-year periods. The new plan targets workforce, offshore delivery mix, organizational structure, facilities, and data centers.
  • The U.S. tax law enacted in December produced a provisional $320 million deferred-tax benefit from the lower corporate rate and a provisional $386 million transition-tax expense on foreign earnings. Management said the tax accounting remained incomplete and amounts could change.
  • Debt rose substantially following the merger, while DXC also refinanced and repaid borrowings. Cash dividends declared were $0.54 per share for the first nine months; the company stated a fiscal 2018 target of $0.72 per share, subject to board approval.

Outlook, risks, contingencies, and unusual items

  • The filing gives no specific revenue or earnings forecast. Management described approximately $1.0 billion of anticipated first-year merger synergies, but stated that timing, amount, and costs to achieve them are not assured.
  • DXC agreed to separate its USPS business and combine it with Vencore and KeyPoint into a new public company. The transaction remained subject to conditions, including regulatory, registration, and tax-opinion requirements; completion and timing were not assured. Proposed terms included $1.05 billion of consideration to DXC and an approximately $400 million cash payment in the acquisitions of Vencore and KeyPoint.
  • Merger purchase accounting remained preliminary. The company recorded substantial acquired goodwill and intangible assets and continued to refine fair values. It also classified certain amended HPES leases as capital leases, recording a $977 million lease liability and $594 million in leased assets, with a corresponding goodwill adjustment.
  • Notable legal matters include an $84.2 million arbitration award to Kemper, plus interest and costs, which DXC was contesting; and a jury verdict against the company in a wage-and-hour case, with damages still to be determined. Other disclosed litigation and investigations include the New York City Medicaid matter, Navy Yard claims, and a sanctions-law voluntary disclosure. DXC said it could not estimate possible losses for certain matters.
  • Other exposures include $6.182 billion of minimum purchase commitments, $2.484 billion of operating lease payments, currency and interest-rate risks, and uncertainty around implementation of the new tax law. The company reported approximately 56% of revenue from outside the U.S.; management said a modeled 10% adverse dollar move would not materially affect pretax income after expense offsets.
  • Disclosure controls were assessed as effective at period-end. A new consolidation and reporting system was completed during the quarter; management said related control changes had not materially affected internal control over financial reporting.

Important facts for investors to verify

  • Use pro forma and constant-currency comparisons to assess underlying revenue trends; reported year-over-year results include the merger.
  • Track revenue declines, contract renewals and awards, and whether announced synergies translate into sustainable operating improvement.
  • Assess recurring profitability separately from restructuring, acquisition amortization, integration costs, and the provisional tax-law effects.
  • Monitor cash generation, working capital, debt maturities, lease obligations, and the extent to which liquidity depends on credit facilities or receivables-sale programs.
  • Follow final purchase-accounting adjustments, tax estimates, and the status and potential financial effects of the USPS separation and significant legal matters.