DXC Technology Company — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2020, ended September 30, 2019; comparison is to the corresponding periods of fiscal 2019. Amounts are in U.S. dollars unless stated otherwise.
Business context
DXC provides IT services through Global Business Services (GBS) and Global Infrastructure Services (GIS). It completed its $2.0 billion Luxoft acquisition on June 14, 2019. The former U.S. Public Sector business had been separated in May 2018 and is presented as discontinued operations in prior-period results.
Key financial metrics
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Revenue | $4.851 billion | $5.013 billion | $9.741 billion | $10.295 billion |
| Net income (loss) | $(2.115) billion | $259 million | $(1.947) billion | $525 million |
| Diluted EPS from continuing operations | $(8.19) | $0.92 | $(7.44) | $1.69 |
| Adjusted EBIT, non-GAAP | $529 million | $799 million | $1.181 billion | $1.602 billion |
| Cash from operating activities | Not separately stated | Not separately stated | $1.585 billion | $849 million |
- Q2 revenue declined 3.2%; six-month revenue declined 5.4%. Constant-currency declines were 0.8% and 2.6%, respectively.
- Q2 operating results included a $2.887 billion non-cash goodwill impairment charge ($2.625 billion in GBS and $262 million in GIS) and a $632 million gain on an arbitration award. DXC received $666 million in total, including $34 million of pre-award interest.
- Segment revenue diverged: Q2 GBS grew 8.2% to $2.285 billion, while GIS fell 11.6% to $2.566 billion. For six months, GBS grew 2.8% and GIS declined 11.3%. Management cited acquisition contributions to GBS growth and ongoing contraction in traditional infrastructure and application-maintenance services.
- Adjusted EBIT declined 33.8% in Q2 and 26.3% for the six-month period. Q2 adjusted EBIT margin was approximately 10.9%, compared with 15.9% a year earlier; six-month margin was approximately 12.1%, compared with 15.6%.
- Cash and cash equivalents were $2.880 billion at September 30, 2019, versus $2.899 billion at March 31. Six-month operating cash flow included $668 million received on the arbitration award.
- Total debt was $9.169 billion, up from $7.412 billion at March 31; net debt was $6.289 billion. Debt-to-total capitalization increased to 50.8% from 38.7%. The increase primarily reflected term loans used to finance Luxoft; DXC repaid $500 million of notes due 2020. The company reported compliance with its financial covenants.
- Total liquidity was $6.880 billion: $2.880 billion cash and $4.000 billion available under its revolving credit facility. Management expected cash and operating cash generation to cover normal operating requirements for the next 12 months.
- Shareholders received $757 million through $650 million of repurchases and approximately $107 million of dividends during the six months. The six-month dividend declared was $0.42 per share.
Material changes and unusual items
- The goodwill impairment followed a sustained decline in DXC’s share price and market capitalization; management said further share-price declines or other impairment indicators could trigger additional charges.
- The Luxoft acquisition added $259 million of revenue and $7 million of net loss to reported results from the acquisition date through September 30. Purchase-price allocations remained preliminary.
- Costs of services rose to 75.8% of revenue in Q2 from 70.1% a year earlier; management attributed the pressure to revenue declines outpacing cost reductions in traditional infrastructure businesses.
- DXC adopted lease accounting standard ASC 842 on April 1, 2019, recording $1.7 billion of assets and $1.8 billion of liabilities at adoption, without material impact on earnings or cash flows. It also extended the estimated useful lives of certain computer equipment, reducing depreciation expense by $56 million in Q2 and $111 million for six months.
- The U.S. receivables facility was amended, increasing its investment limit to $750 million and extending its termination date to August 2020. At September 30, $650 million of receivables had been sold and derecognized; reported availability was $663 million.
- The company disclosed plans to explore strategic alternatives for its U.S. state and local healthcare business-process services, horizontal business-process services, and workplace and mobility businesses. No transaction or outcome was assured.
Outlook, risks and contingencies
- The filing provides no specific revenue or earnings guidance. DXC reported approximately $25.9 billion of remaining performance obligations and expected to recognize about 26% in fiscal 2020.
- Management identified risks around continuing declines in legacy services, execution of strategic priorities, acquisition integration and Luxoft synergies, employee retention, customer contract performance, foreign exchange, and access to financing. More than 62% of first-half revenue was earned internationally; foreign exchange reduced reported revenue by 2.8% in the period.
- DXC reported ongoing tax examinations and uncertain tax positions; it said reasonably possible reductions in uncertain-tax-position liabilities over the next 12 months were $13 million to $17 million, excluding interest, penalties, and tax carry-forwards.
- Contingencies include a Perspecta arbitration demand seeking at least $120 million and disputing $39 million of DXC invoices; an employment-law damages award of $18.75 million, with plaintiffs also seeking $14.1 million in fees and costs; and other securities, shareholder, and commercial matters. DXC disputed several claims and intended to defend them. For most disclosed matters, the company said it could not reasonably estimate a possible loss or range.
- DXC stated that disclosure controls were effective as of September 30, 2019. It also cautioned that outcomes of litigation and other contingencies could be material and adverse in a particular future period.
Important facts for investors to verify
- Whether GBS growth can offset sustained GIS and legacy-services declines, and how much reported GBS growth reflects acquisitions.
- Goodwill impairment valuation assumptions and the risk of further impairment, alongside progress on restructuring and cost reductions.
- Underlying cash generation excluding the one-time arbitration proceeds, and the sustainability of liquidity amid higher debt and acquisition-related financing.
- Luxoft integration, realized synergies, and final purchase-price allocation.
- Developments in proposed strategic alternatives, tax examinations, the Perspecta dispute, and other material legal matters.