UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended December 31, 2019
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from _____________ to ____________
Commission File No.: 001-38033
 | DXC TECHNOLOGY COMPANY |
(Exact name of registrant as specified in its charter) | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||
, | ||||||
(Address of principal executive offices) | (Zip Code) | |||||
Registrant's telephone number, including area code: (703 ) 245-9675
Securities registered pursuant to Section 12(b) of the Act: | ||||||
Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||
Securities registered pursuant to Section 12(g) of the Act: None | ||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
x | Accelerated Filer | o | ||||||
Non-accelerated Filer | o | Smaller reporting company | ||||||
Emerging growth company | ||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
TABLE OF CONTENTS
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PART I
ITEM 1. FINANCIAL STATEMENTS
Index to Condensed Consolidated Financial Statements
Page | |
1
DXC TECHNOLOGY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
(in millions, except per-share amounts) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||
Revenues | $ | $ | $ | $ | ||||||||||||
Costs of services (excludes depreciation and amortization and restructuring costs) | ||||||||||||||||
Selling, general, and administrative (excludes depreciation and amortization and restructuring costs) | ||||||||||||||||
Depreciation and amortization | ||||||||||||||||
Goodwill impairment losses | ||||||||||||||||
Restructuring costs | ||||||||||||||||
Interest expense | ||||||||||||||||
Interest income | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Gain on arbitration award | ( | ) | ||||||||||||||
Other income, net | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Total costs and expenses | ||||||||||||||||
Income (loss) from continuing operations before income taxes | ( | ) | ||||||||||||||
Income tax expense | ||||||||||||||||
Income (loss) from continuing operations | ( | ) | ||||||||||||||
Income from discontinued operations, net of taxes | ||||||||||||||||
Net income (loss) | ( | ) | ||||||||||||||
Less: net income attributable to non-controlling interest, net of tax | ||||||||||||||||
Net income (loss) attributable to DXC common stockholders | $ | $ | $ | ( | ) | $ | ||||||||||
Income (loss) per common share: | ||||||||||||||||
Basic: | ||||||||||||||||
Continuing operations | $ | $ | $ | ( | ) | $ | ||||||||||
Discontinued operations | ||||||||||||||||
$ | $ | $ | ( | ) | $ | |||||||||||
Diluted: | ||||||||||||||||
Continuing operations | $ | $ | $ | ( | ) | $ | ||||||||||
Discontinued operations | ||||||||||||||||
$ | $ | $ | ( | ) | $ | |||||||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
2
DXC TECHNOLOGY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||||
Net income (loss) | $ | $ | $ | ( | ) | $ | ||||||||||||
Other comprehensive income (loss), net of taxes: | ||||||||||||||||||
Foreign currency translation adjustments, net of tax (1) | ( | ) | ( | ) | ||||||||||||||
Cash flow hedges adjustments, net of tax (2) | ( | ) | ( | ) | ( | ) | ||||||||||||
Available-for-sale securities, net of tax (3) | ( | ) | ||||||||||||||||
Pension and other post-retirement benefit plans, net of tax: | ||||||||||||||||||
Prior service cost, net of tax (4) | ( | ) | ( | ) | ||||||||||||||
Amortization of prior service cost, net of tax (5) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||
Pension and other post-retirement benefit plans, net of tax | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||
Other comprehensive income (loss), net of taxes | ( | ) | ( | ) | ||||||||||||||
Comprehensive income (loss) | ( | ) | ||||||||||||||||
Less: comprehensive income attributable to non-controlling interest | ||||||||||||||||||
Comprehensive income (loss) attributable to DXC common stockholders | $ | $ | $ | ( | ) | $ | ||||||||||||
(1) Tax benefit related to foreign currency translation adjustments was $15 and $2 for the three and nine months ended December 31, 2019, respectively. There was no tax expense related to foreign currency translation adjustments during the three and nine months ended December 31, 2018.
(2) Tax (benefit) expense related to cash flow hedge adjustments was $(1 ) and $(1 ) for the three and nine months ended December 31, 2019, respectively, and $5 and $(5 ) for the three and nine months ended December 31, 2018, respectively.
(3) Tax expense related to available-for-sale securities was $0 and $1 for the three and nine months ended December 31, 2019, respectively. There was no tax expense related to available-for-sale securities during the three and nine months ended December 31, 2018.
(4) There was no tax benefit related to prior service costs during the three and nine months ended December 31, 2019. Tax benefit related to prior service costs was $5 and $5 for the three and nine months ended December 31, 2018, respectively.
(5) Tax benefit related to amortization of prior service costs was $0 and $1 for the three and nine months ended December 31, 2019, respectively, and $0 and $1 for the three and nine months ended December 31, 2018, respectively.
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
DXC TECHNOLOGY COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
As of | ||||||||
(in millions, except per-share and share amounts) | December 31, 2019 | March 31, 2019 | ||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | $ | ||||||
Receivables and contract assets, net of allowance for doubtful accounts of $76 and $60 | ||||||||
Prepaid expenses | ||||||||
Other current assets | ||||||||
Total current assets | ||||||||
Intangible assets, net of accumulated amortization of $4,262 and $3,399 | ||||||||
Operating right-of-use assets, net | — | |||||||
Goodwill | ||||||||
Deferred income taxes, net | ||||||||
Property and equipment, net of accumulated depreciation of $4,317 and $3,958 | ||||||||
Other assets | ||||||||
Total Assets | $ | $ | ||||||
LIABILITIES and EQUITY | ||||||||
Current liabilities: | ||||||||
Short-term debt and current maturities of long-term debt | ||||||||
Accounts payable | ||||||||
Accrued payroll and related costs | ||||||||
Current operating lease liabilities | — | |||||||
Accrued expenses and other current liabilities | ||||||||
Deferred revenue and advance contract payments | ||||||||
Income taxes payable | ||||||||
Total current liabilities | ||||||||
Long-term debt, net of current maturities | ||||||||
Non-current deferred revenue | ||||||||
Non-current operating lease liabilities | — | |||||||
Non-current income tax liabilities and deferred tax liabilities | ||||||||
Other long-term liabilities | ||||||||
Total Liabilities | ||||||||
Commitments and contingencies | ||||||||
DXC stockholders’ equity: | ||||||||
Preferred stock, par value $.01 per share, 1,000,000 shares authorized, none issued as of December 31, 2019 and March 31, 2019 | ||||||||
Common stock, par value $.01 per share, 750,000,000 shares authorized, 255,605,750 issued as of December 31, 2019 and 270,213,891 issued as of March 31, 2019 | ||||||||
Additional paid-in capital | ||||||||
(Accumulated deficit) retained earnings | ( | ) | ||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ||||
Treasury stock, at cost, 2,132,967 and 1,788,658 shares as of December 31, 2019 and March 31, 2019 | ( | ) | ( | ) | ||||
Total DXC stockholders’ equity | ||||||||
Non-controlling interest in subsidiaries | ||||||||
Total Equity | ||||||||
Total Liabilities and Equity | $ | $ | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
DXC TECHNOLOGY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine Months Ended | ||||||||
(in millions) | December 31, 2019 | December 31, 2018 | ||||||
Cash flows from operating activities: | ||||||||
Net (loss) income | $ | ( | ) | $ | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | ||||||||
Goodwill impairment losses | ||||||||
Operating right-of-use expense | ||||||||
Share-based compensation | ||||||||
Loss (gain) on dispositions | ( | ) | ||||||
Unrealized foreign currency exchange loss (gain) | ( | ) | ||||||
Other non-cash charges, net | ( | ) | ||||||
Changes in assets and liabilities, net of effects of acquisitions and dispositions: | ||||||||
Decrease (increase) in assets | ( | ) | ||||||
Decrease in operating lease liability | ( | ) | ||||||
Decrease in other liabilities | ( | ) | ( | ) | ||||
Net cash provided by operating activities | ||||||||
Cash flows from investing activities: | ||||||||
Purchases of property and equipment | ( | ) | ( | ) | ||||
Payments for transition and transformation contract costs | ( | ) | ( | ) | ||||
Software purchased and developed | ( | ) | ( | ) | ||||
Payments for acquisitions, net of cash acquired | ( | ) | ( | ) | ||||
Business dispositions | ( | ) | ||||||
Cash collections related to deferred purchase price receivable | ||||||||
Proceeds from sale of assets | ||||||||
Short-term investing | ( | ) | ||||||
Other investing activities, net | ||||||||
Net cash used in investing activities | ( | ) | ( | ) | ||||
Cash flows from financing activities: | ||||||||
Borrowings of commercial paper | ||||||||
Repayments of commercial paper | ( | ) | ( | ) | ||||
Borrowings on long-term debt, net of discount | ||||||||
Principal payments on long-term debt | ( | ) | ( | ) | ||||
Payments on finance leases and borrowings for asset financing | ( | ) | ( | ) | ||||
Borrowings for USPS spin transaction | ||||||||
Proceeds from bond issuance | ||||||||
Proceeds from stock options and other common stock transactions | ||||||||
Taxes paid related to net share settlements of share-based compensation awards | ( | ) | ( | ) | ||||
Repurchase of common stock and advance payment for accelerated share repurchase | ( | ) | ( | ) | ||||
Dividend payments | ( | ) | ( | ) | ||||
Other financing activities, net | ( | ) | ||||||
Net cash used in financing activities | ( | ) | ( | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | ( | ) | ||||||
Net decrease in cash and cash equivalents | ( | ) | ( | ) | ||||
Cash and cash equivalents at beginning of year | ||||||||
Cash and cash equivalents at end of period | $ | $ | ||||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
DXC TECHNOLOGY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (unaudited)
Three Months Ended December 31, 2019 | |||||||||||||||||||||||||||
(in millions, except shares in thousands) | Common Stock | Additional Paid-in Capital | Retained Earnings (Accumulated Deficit) | Accumulated Other Comprehensive Loss | Treasury Stock (1) | Total DXC Equity | Non- Controlling Interest | Total Equity | |||||||||||||||||||
Shares | Amount | ||||||||||||||||||||||||||
Balance at September 30, 2019 | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | $ | |||||||||||||
Net income | |||||||||||||||||||||||||||
Other comprehensive income | |||||||||||||||||||||||||||
Share-based compensation expense | |||||||||||||||||||||||||||
Acquisition of treasury stock | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Share repurchase program | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||
Stock option exercises and other common stock transactions | |||||||||||||||||||||||||||
Dividends declared ($0.21 per share) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Non-controlling interest distributions and other | — | ( | ) | ( | ) | ||||||||||||||||||||||
Balance at December 31, 2019 | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | $ | |||||||||||||
Three Months Ended December 31, 2018 | |||||||||||||||||||||||||||
(in millions, except shares in thousands) | Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Loss | Treasury Stock | Total DXC Equity | Non- Controlling Interest | Total Equity | |||||||||||||||||||
Shares | Amount | ||||||||||||||||||||||||||
Balance at September 30, 2018 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | $ | |||||||||||||||
Net income | |||||||||||||||||||||||||||
Other comprehensive loss | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Share-based compensation expense | |||||||||||||||||||||||||||
Acquisition of treasury stock | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Share repurchase program | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||||||||
Stock option exercises and other common stock transactions | |||||||||||||||||||||||||||
Dividends declared ($0.19 per share) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Non-controlling interest distributions and other | — | ( | ) | ( | ) | ||||||||||||||||||||||
Balance at December 31, 2018 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | $ | |||||||||||||||
6
DXC TECHNOLOGY COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (unaudited)
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (unaudited)
Nine Months Ended December 31, 2019 | |||||||||||||||||||||||||||
(in millions, except shares in thousands) | Common Stock | Additional Paid-in Capital | Retained Earnings (Accumulated Deficit) | Accumulated Other Comprehensive Loss | Treasury Stock (1) | Total DXC Equity | Non- Controlling Interest | Total Equity | |||||||||||||||||||
Shares | Amount | ||||||||||||||||||||||||||
Balance at March 31, 2019 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | $ | |||||||||||||||
Net loss | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Other comprehensive income (loss) | |||||||||||||||||||||||||||
Share-based compensation expense | |||||||||||||||||||||||||||
Acquisition of treasury stock | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Share repurchase program | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||||||||
Stock option exercises and other common stock transactions | |||||||||||||||||||||||||||
Dividends declared ($0.63 per share) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Non-controlling interest distributions and other | — | ||||||||||||||||||||||||||
Balance at December 31, 2019 | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | $ | |||||||||||||
Nine Months Ended December 31, 2018 | |||||||||||||||||||||||||||
(in millions, except shares in thousands) | Common Stock | Additional Paid-in Capital | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Total DXC Equity | Non- Controlling Interest | Total Equity | |||||||||||||||||||
Shares | Amount | ||||||||||||||||||||||||||
Balance at March 31, 2018 | $ | $ | $ | $ | $ | ( | ) | $ | $ | $ | |||||||||||||||||
Cumulative effect of adopting the new revenue standard | |||||||||||||||||||||||||||
Net income | |||||||||||||||||||||||||||
Other comprehensive loss | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Share-based compensation expense | |||||||||||||||||||||||||||
Acquisition of treasury stock | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Share repurchase program | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||||||||
Stock option exercises and other common stock transactions | |||||||||||||||||||||||||||
Dividends declared ($0.57 per share) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Non-controlling interest distributions and other | — | ( | ) | ( | ) | ||||||||||||||||||||||
Divestiture of USPS | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||||||||||||
Balance at December 31, 2018 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | $ | |||||||||||||||
(1) 2,132,967 treasury shares as of December 31, 2019.
The accompanying notes are an integral part of these condensed consolidated financial statements.
7
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Note 1 - Summary of Significant Accounting Policies
Business
DXC Technology Company ("DXC" or the "Company") 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 its enterprise technology stack to deliver new levels of performance, competitiveness and customer experiences.
Luxoft Acquisition
On June 14, 2019, DXC completed its acquisition of Luxoft Holding, Inc. ("Luxoft"), a global digital strategy and software engineering firm (the "Luxoft Acquisition"). The acquisition builds on DXC’s unique value proposition as an end-to-end, mainstream IT and digital services market leader, and strengthens the Company’s ability to design and deploy transformative digital solutions for clients at scale. See Note 3 - "Acquisitions" for further information.
Separation of USPS
On May 31, 2018, DXC completed the separation of its U.S. Public Sector business ("USPS" or the "Separation"), and combination with Vencore Holding Corp. ("Vencore") and KeyPoint Government Solutions ("Keypoint") (the "Mergers") to form Perspecta Inc. ("Perspecta"), an independent public company (collectively, the "USPS Separation and Mergers"). Under the terms of the separation agreements, on May 31, 2018, stockholders who held DXC common stock at the close of business on May 25, 2018 (the “Record Date”), received a distribution of one share of Perspecta common stock for every two shares of DXC common stock held as of the Record Date (the "Distribution"). See Note 4 - "Divestitures" for more information.
Basis of Presentation
In order to make this report easier to read, DXC refers throughout to (i) the interim unaudited Condensed Consolidated Financial Statements as the “financial statements,” (ii) the Condensed Consolidated Statements of Operations as the “statements of operations,” (iii) the Condensed Consolidated Statement of Comprehensive Income (Loss) as the "statements of comprehensive income," (iv) the Condensed Consolidated Balance Sheets as the “balance sheets,” and (v) the Condensed Consolidated Statements of Cash Flows as the “statements of cash flows.” In addition, references throughout to numbered “Notes” refer to the numbered Notes in these Notes to Condensed Consolidated Financial Statements, unless otherwise noted.
The accompanying financial statements include the accounts of DXC, its consolidated subsidiaries, and those business entities in which DXC maintains a controlling interest. Investments in business entities in which the Company does not have control, but has the ability to exercise significant influence over operating and financial policies, are accounted for by the equity method. Other investments are accounted for by the cost method. Non-controlling interests are presented as a separate component within equity in the balance sheets. Net earnings attributable to the non-controlling interests are presented separately in the statements of operations and comprehensive income attributable to non-controlling interests are presented separately in the statements of comprehensive income. All intercompany transactions and balances have been eliminated. Certain amounts reported in the previous year have been reclassified to conform to the current year presentation. During the third quarter, DXC corrected an immaterial classification error related to the presentation of deferred revenue and advance contract payments and non-current deferred revenue that first occurred during fiscal 2018.
8
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
The financial statements of the Company have been prepared in accordance with the rules and regulations of the U.S. Securities and Exchange Commission for quarterly reports and accounting principles generally accepted in the United States ("GAAP"). Certain disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules. These financial statements should therefore be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2019 ("fiscal 2019").
Use of Estimates
The preparation of financial statements in conformity with GAAP, requires the Company's management to make estimates and assumptions that affect amounts reported in the financial statements. The Company bases its estimates on assumptions regarding historical experience, currently available information and anticipated developments that it believes are reasonable and appropriate. However, because the use of estimates involves an inherent degree of uncertainty, actual results could differ from those estimates. In the opinion of the Company's management, the accompanying financial statements of DXC contain all adjustments, including normal recurring adjustments, necessary to present fairly the Company's financial statements. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full fiscal year.
Leases
Effective April 1, 2019, the Company adopted ASU 2016-02, "Leases, Topic ASC 842" using the modified retrospective method. Refer to Note 2 - "Recent Accounting Pronouncements" and Note 7 - "Leases" for further discussion of the impact of adoption and other required disclosures. The Company determines if an arrangement is a lease at inception by evaluating whether the arrangement conveys the right to use an identified asset and whether DXC obtains substantially all economic benefits from and has the ability to direct the use of the asset. Operating leases are included in operating right-of-use ("ROU") assets, net, current operating lease liabilities and non-current operating lease liabilities in DXC's balance sheets. Finance leases are included in property and equipment, net, short-term debt and current maturities of long-term debt and long-term debt, net of current maturities in DXC's balance sheets.
ROU assets represent the Company's right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating ROU assets and operating lease liabilities are recognized at commencement based on the present value of lease payments over the lease term.
As most of the Company's leases do not provide an implicit rate, DXC uses its incremental borrowing rate based on the information available at commencement to determine the present value of lease payments. The incremental borrowing rate is the rate of interest that DXC would have to pay to borrow, on a collateralized basis, an amount equal to the lease payments, in a similar economic environment and over a similar term. The rate is dependent on several factors, including the lease term, currency of the lease payments and the Company's credit ratings.
Operating ROU assets also includes any lease payments made and excludes lease incentives. The Company's lease terms may include options to extend or terminate the lease. Operating ROU assets and lease liabilities include these options when it is reasonably certain that they will be exercised. Lease arrangements generally do not contain any residual value guarantees or material restrictive covenants.
9
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Goodwill Impairment Analysis
Effective July 1, 2019, the Company adopted ASU 2017-04, " Intangibles-Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment" using the prospective method. Refer to Note 2 - "Recent Accounting Pronouncements" and Note 11 - "Goodwill" for further discussion of impact of adoption and other required disclosures. The Company tests goodwill for impairment on an annual basis, as of the first day of the second fiscal quarter, and between annual tests if circumstances change, or if an event occurs that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company has defined its reporting units as its reportable segments. A significant amount of judgment is involved in determining whether an event indicating impairment has occurred between annual testing dates. Such indicators include: a significant decline in the Company's stock price, a significant decline in expected future cash flows, a significant adverse change in legal factors or in the business climate, unanticipated competition, the disposal of a significant component of a reporting unit and the testing for recoverability of a significant asset group within a reporting unit.
The Company initially assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. This qualitative assessment considers all relevant factors specific to the reporting units, including macroeconomic conditions; industry and market considerations; overall financial performance; and relevant entity-specific events.
If the Company determines that it is not more likely that the carrying amount for a reporting unit is less than its fair value, then subsequent quantitative goodwill impairment testing is not required. If the Company determines that it is more likely than not that the carrying amount for a reporting unit is greater than its fair value, then it proceeds with a subsequent quantitative goodwill impairment test.
The Company has the option to bypass the initial qualitative assessment stage and proceed directly to the quantitative goodwill impairment test. The quantitative goodwill impairment test compares each reporting unit’s fair value to its carrying value. If the reporting unit’s fair value exceeds its carrying value, no further procedures are required. However, if a reporting unit’s fair value is less than its carrying value, then an impairment charge is recorded in the amount of the excess.
When the Company performs the quantitative goodwill impairment test for a reporting unit, it estimates the fair value of the reporting unit using both the income approach and the market approach. The income approach uses a discounted cash flow method in which the estimated future cash flows and terminal values for each reporting unit are discounted to present value using a discount rate. Cash flow projections are based on management's estimates of economic and market conditions, which drive key assumptions of revenue growth rates, operating margins, capital expenditures and working capital requirements. The discount rate is based on the specific risk characteristics of each reporting unit, the weighted-average cost of capital and its underlying forecasts. The market approach estimates fair value by applying performance-metric multiples to the reporting unit's prior and expected operating performance. The multiples are derived from comparable publicly traded companies that have operating and investment characteristics similar to those of the reporting unit. If the fair value of the reporting unit derived using one approach is significantly different from the fair value estimate using the other approach, the Company reevaluates its assumptions used in the two models. Assumptions are modified as considered appropriate under the circumstances until the two models yield similar and reasonable results. The fair values determined by the market approach and income approach, as described above, are weighted to determine the fair value for each reporting unit. The weighting ascribed to the market approach fair value assigned to each reporting unit is influenced by two primary factors: 1) the number of comparable publicly traded companies used in the market approach, and 2) the similarity of the operating and investment characteristics of the reporting units to the comparable publicly traded companies used in the market approach.
10
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
If DXC performs a quantitative goodwill impairment test for all of its reporting units in conjunction with its annual goodwill testing, it also compares the sum of all of its reporting units’ fair values to the Company's market capitalization (per-share stock price multiplied by the number of shares outstanding) and calculates an implied control premium representing the excess of the sum of the reporting units’ fair values over the market capitalization. The Company evaluates the reasonableness of the control premium by comparing it to control premiums derived from recent comparable business combinations. If the implied control premium is not supported by market data, the Company reconciles its fair value estimates of the reporting units to a market capitalization supported by relevant market data. As a result, when DXC’s stock price and thus market capitalization is low relative to the sum of the estimated fair value of its reporting units, this reconciliation can result in reductions to the estimated fair values for the reporting units.
Property and Equipment
Property and equipment, which includes assets under capital leases, are stated at cost less accumulated depreciation. Depreciation is computed predominantly on a straight-line basis over the estimated useful lives of the assets or the remaining lease term, whichever is shorter. The estimated useful lives of DXC’s property and equipment are as follows:
Buildings | Up to 40 years |
Computers and related equipment | 4 to 7 years |
Furniture and other equipment | 3 to 15 years |
Leasehold improvements | Shorter of lease term or useful life up to 20 years |
11
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 2 - Recent Accounting Pronouncements
During the nine months ended December 31, 2019, DXC adopted the following Accounting Standards Updates ("ASU") issued by the Financial Accounting Standards Board:
Date Issued and ASU | Date Adopted and Method | Description | Impact |
February 2016 ASU 2016-02 "Leases (Topic 842)" | April 1, 2019 Modified retrospective | This update is intended to increase transparency and comparability among organizations by recognizing virtually all lease assets and lease liabilities on the balance sheet and disclosing key information about lease arrangements. This update must be adopted using a modified retrospective transition at the beginning of the earliest period presented or at the adoption date recognizing a cumulative adjustment to the opening balance of retained earnings in the period of adoption and provides for certain practical expedients. | The Company adopted this update utilizing the simplified transition method allowing the Company to not restate comparative periods and apply Topic 842 beginning on April 1, 2019. During adoption, the Company implemented changes in its systems, including the implementation of new lease accounting software, internal controls, business processes, and accounting policies related to both the implementation of, and ongoing compliance with, the new guidance. The adoption resulted in following impacts. The Company recorded increases of $1.7 billion in assets and $1.8 billion in liabilities as of April 1, 2019, due to the recording of operating ROU assets and operating lease liabilities for lease obligations that were historically classified as operating leases. The Company's cumulative adjustment to the opening balance of retained earnings was not material. Additionally, the update did not have a material impact on the statements of operations or statements of cash flows. DXC elected the practical expedient package permitted under Topic 842, which among other things, permits the Company not to reassess historical conclusions related to contracts that contain leases, lease classification and initial direct costs for leases that commenced prior to the adoption date. DXC applied the lessee component election, allowing the Company to account for lease and non-lease components as a single lease component. In addition, DXC made an accounting policy election to not capitalize leases with an initial term of 12 months or less that do not contain a ‘reasonably certain’ purchase option. Refer to Note 7 - "Leases" for additional information. |
February 2018 ASU 2018-02 - "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" | April 1, 2019 Retrospective | This update provides an option to reclassify stranded tax effects within accumulated other comprehensive income ("AOCI") to retained earnings in each period in which the effect (or portion thereof) of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recorded. | The Company adopted this update and opted to not elect to reclassify any stranded tax effects within AOCI to retained earnings, and as such, the adoption of ASU 2018-02 did not have an effect on its condensed consolidated financial statements. In accordance with its accounting policy, the Company uses the portfolio approach and will release income tax effects from AOCI once the reason the tax effects were established cease to exist (e.g., when available-for-sale debt securities are sold or if a pension plan is liquidated). |
12
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
January 2017 ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the test for Goodwill Impairment | July 1, 2019 Prospective | This update is intended to simplify goodwill impairment testing by eliminating Step 2 from the goodwill impairment test. Under the new guidance, if a reporting unit’s carrying amount exceeds its fair value, the entity will record an impairment loss based on that difference. The impairment loss will be limited to the amount of goodwill allocated to that reporting unit. Previously, if the fair value of a reporting unit was lower than its carrying amount (Step 1), an entity was required to calculate any impairment loss by comparing the implied fair value of goodwill with its carrying amount (Step 2). Additionally, under the new standard, companies that have reporting units with zero or negative carrying amounts will no longer be required to perform the qualitative assessment to determine whether to perform Step 2 of the goodwill impairment test. As a result, reporting units with zero or negative carrying amounts will generally be expected to pass the simplified impairment test; however, additional disclosure will be required of those companies. | DXC early adopted this guidance on a prospective basis as of July 1, 2019. As a result of adopting this ASU, the Company no longer performs Step 2 while completing its goodwill impairment testing, beginning with its annual goodwill impairment testing performed during the second quarter of fiscal 2020. DXC's impairment testing resulted in a non-cash impairment charge of $2,940 million, consisting of $2,675 million and $265 million in its GBS and GIS reporting units, respectively. See Note 11 - "Goodwill" for additional information. |
The following ASUs were recently issued but have not yet been adopted by DXC:
Date Issued and ASU | DXC Effective Date | Description | Impact |
June 2016 ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” | Fiscal 2021 | This update is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this update replace the existing incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This update must be adopted using a prospective transition approach for debt securities for which an other-than-temporary impairment has been recognized before the effective date. | DXC is currently evaluating its trade receivables and financial arrangements for the potential impact this update may have on its financial statements in future reporting periods. |
August 2018 ASU 2018-15, "Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract" | Fiscal 2021 | This update helps entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement (hosting arrangement) by providing guidance for determining when the arrangement includes a software license. Entities have the option to apply this standard prospectively to all implementation costs incurred after the date of adoption or retrospectively. | DXC is currently evaluating its cloud computing arrangements for the potential impact this update may have on its financial statements in future reporting periods. |
Other recently issued ASUs effective after December 31, 2019 are not expected to have a material effect on DXC's consolidated financial statements.
13
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 3 - Acquisitions
Fiscal 2020 Acquisitions
Luxoft Acquisition
On June 14, 2019, DXC completed the acquisition of Luxoft, a digital service provider whose offerings encompass strategic consulting, custom software development services, and digital solution engineering for total consideration of $2.0 billion. The acquisition will combine Luxoft’s digital engineering capabilities with DXC’s expertise in IT modernization and integration. The purchase agreement (“Merger Agreement”) was entered into by DXC and Luxoft on January 6, 2019 and the transaction was closed on June 14, 2019.
The transaction between DXC and Luxoft is an acquisition, with DXC as the acquirer and Luxoft as the acquiree, based on the fact that DXC acquired 100 % of the equity interests and voting rights in Luxoft, and that DXC is the entity that transferred the cash consideration.
The Company's preliminary estimates of fair values of the assets acquired and the liabilities assumed are based on the information that was available as of the acquisition date, and the Company is continuing to evaluate the underlying inputs and assumptions used in its valuations. Accordingly, these preliminary estimates are subject to change during the measurement period, which is up to one year from the acquisition date. The preliminary estimated purchase price is allocated as follows:
(in millions) | Estimated Fair Value | |||
Cash and cash equivalents | $ | |||
Accounts receivable | ||||
Other current assets | ||||
Total current assets | ||||
Property and equipment | ||||
Intangible assets | ||||
Other assets | ||||
Total assets acquired | ||||
Accounts payable, accrued payroll, accrued expenses, and other current liabilities | ( | ) | ||
Deferred revenue | ( | ) | ||
Long-term deferred tax liabilities and income tax payable | ( | ) | ||
Other liabilities | ( | ) | ||
Total liabilities assumed | ( | ) | ||
Net identifiable assets acquired | ||||
Goodwill | ||||
Total estimated consideration transferred | $ | |||
Goodwill represents the excess of the purchase price over the fair value of identifiable assets acquired and liabilities assumed at the acquisition date. The goodwill recognized with the acquisition was attributable to the synergies expected to be achieved by combining the businesses of DXC and Luxoft, expected future contracts and the acquired workforce. The cost-saving opportunities are expected to include improved operating efficiencies and asset optimization. The total goodwill arising from the acquisition was allocated to Global Business Services ("GBS") and is not deductible for tax purposes. See Note 11 - "Goodwill."
As of December 31, 2019, DXC has not finalized the determination of fair values allocated to various assets and liabilities, including, but not limited to, receivables; other current assets; property and equipment; intangible assets; other assets; deferred income taxes, net and other income tax liabilities; deferred revenue and advanced contract payments; accounts payable and accrued liabilities; other liabilities; loss contracts; non-controlling interest; and goodwill.
14
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
During the three months ended December 31, 2019, the Company made a number of refinements to the June 14, 2019 preliminary purchase price allocation. These refinements were primarily driven by the Company recording valuation adjustments that decreased developed technology by $69 million, decreased trade names by $23 million and, increased customer related intangibles by $32 million and related deferred tax adjustments which resulted in a decrease in net identifiable assets of $60 million.
Current assets and liabilities
The Company valued current assets and liabilities using existing carrying values as an estimate of the approximate fair value of those items at the acquisition date except for certain contract receivables for which the Company determined preliminary fair value based on a cost plus margin approach.
Property and equipment
The acquired property and equipment are summarized in the following table:
(in millions) | Amount | |||
Land, buildings, and leasehold improvements | $ | |||
Computers and related equipment | ||||
Furniture and other equipment | ||||
Total | $ | |||
During the quarter ended September 30, 2019, DXC updated the fair value allocation to land, buildings and leasehold improvements using the direct capitalization method of the income approach and the cost approach. For all other categories of property and equipment, based on the nature of the assets, the Company determined that the net book value represents the preliminary fair value.
Identified intangible assets
The acquired identifiable intangible assets are summarized in the following table:
(in millions) | Amount | Estimated Useful Lives (Years) | ||||
Customer related intangibles | $ | |||||
Trade names | $ | |||||
Developed technology | $ | |||||
Third-party purchased software | $ | |||||
Total | $ | |||||
Developed technology and third-party purchased software are included in the software category and trade names are included in the other intangible assets category in Note 10 -"Intangible Assets".
The Company estimated the preliminary value of customer relationships using the multi-period excess earnings method under the income approach and the preliminary value of trade names and developed technology using a relief from royalty method under the income approach. The Company determined that the net book value of the purchased software represents the preliminary fair value.
Deferred tax liabilities
The Company preliminarily valued deferred tax liabilities based on statutory tax rates in the jurisdictions of the legal entities where the acquired non-current assets and liabilities are taxed.
15
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Unaudited Results
The Company's condensed consolidated statements of operations includes the following revenues and net income
attributable to Luxoft since the acquisition date:
(in millions) | Three Months Ended December 31, 2019 | Nine Months Ended December 31, 2019(1) | ||||||
Revenues | $ | $ | ||||||
Net income (loss) | $ | $ | ( | ) | ||||
(1) Results for the nine months ended December 31, 2019, reflect operations subsequent to the acquisition date of June 14, 2019, not the full nine-month period.
Fiscal 2019 Acquisitions
Molina Medicaid Solutions Acquisition
On October 1, 2018, DXC completed its acquisition of Molina Medicaid Solutions ("MMS"), a Medicaid Management Information Systems business, from Molina Healthcare, Inc. for total consideration of $233 million. The combination of MMS with DXC expands DXC’s ability to provide services to state agencies in the administration of Medicaid programs, including business processing, information technology development and administrative services.
The purchase price allocation for the MMS acquisition was finalized during the second quarter of fiscal 2020. The purchase price allocation was based upon the current determination of fair values at the date of acquisition as follows: $87 million to current assets, $112 million to intangible assets other than goodwill, $11 million to other assets, $51 million to current liabilities, $18 million to other liabilities and $92 million to goodwill. The goodwill is associated with the Company's Global Business Services ("GBS") segment and is tax deductible. The intangible assets acquired include customer relationships and developed technology which have a 13 -year weighted average estimated useful life.
Other Acquisitions
In addition to the MMS acquisition, DXC completed seven acquisitions to complement the Company's Microsoft Dynamics and ServiceNow offerings and to provide opportunities for future growth. The acquired businesses are included in the results of the GBS segment. The purchase consideration of $232 million includes contingent consideration with an estimated fair value of $41 million. For acquisitions within the measurement period, the Company's purchase price allocation is preliminary and subject to revision as additional information related to the fair value of assets and liabilities becomes available. The purchase price is allocated to assets acquired and liabilities assumed based upon determination of fair values at the dates of acquisition as follows: $74 million to current assets, $71 million to intangible assets other than goodwill, $9 million to other non-current assets, $63 million to current liabilities and $141 million to goodwill. The goodwill is associated with the Company's GBS segment, some of which is tax deductible.
16
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 4 - Divestitures
Separation of USPS
During fiscal 2019, the Company completed the USPS Separation and Mergers to form Perspecta, an independent public company.
Implementation of the Separation and DXC's post-Separation relationship with Perspecta is governed by several agreements, including the following:
• | a Separation and Distribution Agreement; |
• | an Employee Matters Agreement; |
• | a Tax Matters Agreement; |
• | an Intellectual Property Matters Agreement; |
• | a Transition Services Agreement; |
• | a Real Estate Matters Agreement; |
• | an IT Services Agreement and, |
• | a Non-US Agency Agreement. |
These agreements provide for the allocation of assets, employees, liabilities and obligations (including property, employee benefits, litigation, and tax-related assets and liabilities) between DXC and Perspecta attributable to periods prior to, at and after the Separation. In addition, DXC and Perspecta have service and commercial contracts that generally extend through fiscal 2023. Results for the nine months ended December 31, 2019 include $39 million of revenue and income from continuing operations before taxes associated with the IT services agreement.
Pursuant to the Separation and Distribution Agreement, immediately prior to the Separation, Perspecta made a net cash payment of $984 million to DXC, which reflects transaction consideration of $1,050 million less $66 million in principal amount of debt that was outstanding at a subsidiary of Perspecta. Perspecta financed the payment through borrowings under a new senior secured term loan facility.
DXC's former Chief Executive Officer, J. Michael Lawrie, served as DXC's Chairman until his retirement on December 31, 2019. Mr. Lawrie became Chairman of Perspecta effective as of the Separation and he continues to serve as Chairman of Perspecta. DXC's Chief Financial Officer, Paul N. Saleh, served as a Director of Perspecta until his term ended on August 13, 2019. Due to Mr. Lawrie's and Mr. Saleh's leadership positions at DXC and Perspecta, Perspecta is considered a related party under ASC 850 "Related Party Disclosures" for periods subsequent to the Separation. Transactions with Perspecta were immaterial to the Company's financial statements for the three and nine months ended December 31, 2019 and balances due to and from Perspecta were immaterial to the Company's balance sheet as of December 31, 2019.
17
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
The following is a summary of the operating results for USPS which have been reflected within income from discontinued operations, net of tax:
(in millions) | Nine Months Ended December 31, 2018(1) | |||
Revenue | $ | |||
Costs of services | ||||
Selling, general and administrative | ||||
Depreciation and amortization | ||||
Restructuring costs | ||||
Interest expense | ||||
Other income, net | ( | ) | ||
Total costs and expenses | ||||
Total income from discontinued operations, before income taxes | ||||
Income tax expense | ||||
Total income from discontinued operations | $ | |||
There was no gain or loss on disposition recognized as a result of the Separation.
The following selected financial information of USPS is included in the statements of cash flows:
(in millions) | Nine Months Ended December 31, 2018 | |||
Depreciation | $ | |||
Amortization | $ | |||
Capital expenditures | $ | |||
Significant operating non-cash items: | ||||
Gain on dispositions | $ | |||
18
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 5 - Earnings (Loss) per Share
Basic EPS is computed using the weighted average number of shares of common stock outstanding during the period. Diluted EPS reflects the incremental shares issuable upon the assumed exercise of stock options and equity awards. The following table reflects the calculation of basic and diluted EPS:
Three Months Ended | Nine Months Ended | |||||||||||||||
(in millions, except per-share amounts) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||
Net income (loss) attributable to DXC common shareholders: | ||||||||||||||||
From continuing operations | $ | $ | $ | ( | ) | $ | ||||||||||
From discontinued operations | $ | $ | $ | $ | ||||||||||||
Common share information: | ||||||||||||||||
Weighted average common shares outstanding for basic EPS | ||||||||||||||||
Dilutive effect of stock options and equity awards | ||||||||||||||||
Weighted average common shares outstanding for diluted EPS | ||||||||||||||||
Earnings (Loss) per share: | ||||||||||||||||
Basic | ||||||||||||||||
Continuing operations | $ | $ | $ | ( | ) | $ | ||||||||||
Discontinued operations | $ | $ | $ | $ | ||||||||||||
Total | $ | 0.32 | $ | $ | ( | ) | $ | |||||||||
Diluted | ||||||||||||||||
Continuing operations | $ | $ | $ | ( | ) | $ | ||||||||||
Discontinued operations | $ | $ | $ | $ | ||||||||||||
Total | $ | 0.32 | $ | $ | ( | ) | $ | |||||||||
For the three months ended December 31, 2019, stock options of 621,028 , and restricted stock units (RSUs) of 2,125,734 , and for the three months ended December 31, 2018, RSUs of 230,803 were excluded in the computation of diluted EPS, which if included, would have been anti-dilutive.
For the nine months ended December 31, 2019, stock options of 818,490 , performance stock units of 351,410 and RSUs of 2,116,898 were excluded from the computation of diluted EPS due to the Company's net loss. For the nine months ended December 31, 2018, RSUs of 28,585 were excluded in the computation of diluted EPS, which if included, would have been anti-dilutive.
19
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 6 - Sale of Receivables
Receivables Facility
The Company has an accounts receivable sales facility (as amended, restated, supplemented or otherwise modified as of December 31, 2019, the "Receivables Facility") with certain unaffiliated financial institutions (the "Purchasers") for the sale of commercial accounts receivable in the United States. Under the Receivables Facility, the Company and certain of its subsidiaries (the "Sellers") sell accounts receivable to DXC Receivables LLC ("Receivables SPV"), a wholly-owned bankruptcy-remote entity, in a true sale. Receivables SPV subsequently sells certain of the receivables in their entirety to the Purchasers pursuant to a receivables purchase agreement. The financial obligations of Receivables SPV to the Purchasers under the Receivables Facility are limited to the assets it owns and non-recourse to the Company. Sales of receivables by Receivables SPV occur continuously and are settled on a monthly basis. During the second quarter of fiscal 2020, Receivables SPV amended the Receivables Facility (the "Amendment") to increase the investment limit from $600 million to $750 million and extend the termination date to August 19, 2020. Under the terms of the amended Receivables Facility, there are no longer deferred purchase prices ("DPP") for receivables as the entire purchase price is paid in cash when the receivables are sold to the Purchasers. Prior to the Amendment, DPP's were realized by Receivables SPV upon the ultimate collection of the underlying receivables sold to the Purchasers. Cash receipts on the DPP were classified as cash flows from investing activities. The DPP was $525 million before the Amendment was executed. Upon execution of the Amendment, the Purchasers extinguished the DPP and returned title to the applicable underlying receivables titles to Receivables SPV. The DPP extinguishment was classified as a non-cash investing activity, please refer to Note 19 - "Cash Flows."
The amount available under the Receivables Facility fluctuates over time based on the total amount of eligible receivables generated during the normal course of business after deducting excess concentrations. As of December 31, 2019, the total availability under the Receivables Facility was $639 million and the amount sold to the Purchasers was $650 million, which was derecognized from the Company's balance sheet. The Receivables Facility is scheduled to terminate on August 19, 2020, but provides for one or more optional one-year extensions, if agreed to by the Purchasers. The Company uses the proceeds from Receivables SPV's sale of receivables under the Receivables Facility for general corporate purposes.
The fair value of the sold receivables approximated book value due to the short-term nature, and as a result, no gain or loss on sale of receivables was recorded.
While the Company guarantees certain non-financial performance obligations of the Sellers, the Purchasers bear customer credit risk associated with the receivables sold under the Receivables Facility and have recourse in the event of credit-related customer non-payment solely to the assets of the Receivables SPV.
The following table is a reconciliation of the beginning and ending balances of the DPP:
(in millions) | As of and for the Three Months Ended | As of and for the Nine Months Ended | ||||||||||
December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||
Beginning balance | $ | $ | $ | |||||||||
Transfers of receivables | ||||||||||||
Collections | ( | ) | ( | ) | ( | ) | ||||||
Change in funding availability | ( | ) | ||||||||||
Facility amendments | ( | ) | ( | ) | ||||||||
Fair value adjustment | ( | ) | ||||||||||
Ending balance | $ | $ | $ | |||||||||
20
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
German Receivables Facility
On October 1, 2019, DXC executed an accounts receivable securitization facility (as amended, restated, supplemented or otherwise modified as of December 31, 2019, the "DE Receivables Facility") with certain unaffiliated financial institutions (the "DE Purchasers") for the sale of commercial accounts receivable in Germany. The facility has an investment limit of €200 million (approximately $225 million as of December 31, 2019). Under the DE Receivables Facility, certain DXC subsidiaries located in Germany (the "DE Sellers") sell accounts receivable to DXC ARFacility Designated Activity Company ("DE Receivables"), a trust owned bankruptcy-remote entity, in a true sale. Pursuant to a receivables purchase agreement, DE Receivables subsequently sells the receivables to the DE Purchasers in return for payments of capital. Sales of receivables by DE Receivables SPV occur continuously and are settled on a monthly basis. The proceeds from the sale of these receivables comprise a combination of cash and a deferred purchase price receivable ("DPP"). The DPP is realized by the Company upon the ultimate collection of the underlying receivables sold to the DE Purchasers. Cash receipts on the DPP are classified as cash flows from investing activities.
The amount available under the DE Receivables Facility fluctuates over time based on the total amount of eligible receivables generated during the normal course of business after deducting excess concentrations. As of December 31, 2019, the total availability under the DE Receivables Facility was approximately $117 million and the drawn amount was $109 million. As of December 31, 2019, the Company recorded a $8 million receivable within receivables, net because the amount of cash proceeds received by the Company under the DE Receivables Facility was less than the total availability. The DE Receivables Facility is scheduled to terminate on September 30, 2020, but provides for one or more optional one-year extensions, if agreed to by the DE Purchasers. The Company uses the proceeds from DE Receivables SPV's sale of receivables under the DE Receivables Facility for general corporate purposes.
The fair value of the sold receivables approximated book value due to the short-term nature, and as a result, no gain or loss on sale of receivables was recorded.
The Company’s risk of loss following the transfer of accounts receivable under the DE Receivables Facility is limited to the DPP outstanding and any short-falls in collections for specified non-credit related reasons after sale. Payment of the DPP is not subject to significant risks other than delinquencies and credit losses on accounts receivable sold under the DE Receivables Facility.
Certain obligations of DE Sellers under the DE Receivables Facility and certain DXC subsidiaries located in Germany, as initial servicers, are guaranteed by the Company under a performance guaranty, made in favor of an administrative agent on behalf of the DE Purchasers. However, the performance guaranty does not cover DE Receivables SPV’s obligations to pay yield, fees or invested amounts to the administrative agent or any of the DE Purchasers.
The following table is a reconciliation of the beginning and ending balances of the DPP:
(in millions) | As of December 31, 2019 | |||
Beginning balance | $ | |||
Transfers of receivables | ||||
Collections | ( | ) | ||
Change in funding availability | ||||
Ending balance | $ | |||
Federal Receivables Sales Facility
Since July 14, 2017, the Company has given a parent guaranty in connection with a federal receivables sales facility with certain financial institutions, under which certain subsidiaries of the Company previously sold eligible federal government obligor receivables, including billed and certain unbilled receivables. In connection with the Separation, the sellers and servicers of the receivables sold under the Federal Receivables Sales Facility were divested and, effective May 31, 2018, the parent guaranty was terminated.
21
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
The following table reflects activity of the Federal Receivables Sales Facility, prior to the Separation:
(in millions) | As of and for the Nine Months Ended December 31, 2018(1) | |||
Transfers of receivables | $ | |||
Collections | $ | |||
Operating cash flow effect | $ | ( | ) | |
(1) Results for the nine months ended December 31, 2018 reflect operations through the Separation date of May 31, 2018, not the full nine-month period.
Note 7 - Leases
The Company has operating and finance leases for data centers, corporate offices, retail stores and certain equipment. Our leases have remaining lease terms of 1 to 13 years, some of which include options to extend the leases for up to 10 years, and some of which include options to terminate the leases within 1 to 3 years.
The components of lease expense were as follows:
(in millions) | Three Months Ended December 31, 2019 | Nine Months Ended December 31, 2019 | ||||||
Operating lease cost | $ | $ | ||||||
Short-term lease cost | ||||||||
Variable lease cost | ||||||||
Sublease income | ( | ) | ( | ) | ||||
Total operating costs | $ | $ | ||||||
Finance lease cost: | ||||||||
Amortization of right-of-use assets | $ | $ | ||||||
Interest on lease liabilities | ||||||||
Total finance lease cost | $ | $ | ||||||
Cash payments made from variable lease costs and short-term leases are not included in the measurement of operating and finance lease liabilities, and as such, are excluded from the supplemental cash flow information stated below. In addition, for the supplemental non-cash information on operating and finance leases, please refer to Note 19 - "Cash Flows."
(in millions) | Nine Months Ended December 31, 2019 | |||
Cash paid for amounts included in the measurement of: | ||||
Operating cash flows from operating leases | $ | |||
Operating cash flows from finance leases | $ | |||
Financing cash flows from finance leases | $ | |||
22
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Supplemental Balance Sheet information related to leases was as follows:
As of | ||||||
(in millions) | Balance Sheet Line Item | December 31, 2019 | ||||
Assets: | ||||||
ROU operating lease assets | Operating right-of-use assets, net | $ | ||||
ROU finance lease assets | Property and Equipment, net | |||||
Total | $ | |||||
Liabilities: | ||||||
Current | ||||||
Operating lease | Current operating lease liabilities | $ | ||||
Finance lease | Short-term debt and current maturities of long-term debt | |||||
Total | $ | |||||
Non-current | ||||||
Operating lease | Non-current operating lease liabilities | $ | ||||
Finance lease | Long-term debt, net of current maturities | |||||
Total | $ | |||||
The following table provides information on the weighted average remaining lease term and weighted average discount rate for operating and finance leases:
Weighted Average remaining lease term: | Years | ||
Operating leases | |||
Finance leases | |||
Weighted average remaining discount rate: | Rate | ||
Operating leases | % | ||
Finance leases | % | ||
The following maturity analysis presents expected undiscounted cash payments for operating and finance leases on an annual basis as of December 31, 2019:
Fiscal year | Operating Leases | |||||||||||
(in millions) | Real Estate | Equipment | Finance Leases | |||||||||
Remainder of 2020 | $ | $ | $ | |||||||||
2021 | ||||||||||||
2022 | ||||||||||||
2023 | ||||||||||||
2024 | ||||||||||||
Thereafter | ||||||||||||
Total lease payments | ||||||||||||
Less: imputed interest | ( | ) | ( | ) | ( | ) | ||||||
Total payments | $ | $ | $ | |||||||||
23
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Prior to fiscal 2020, required disclosure under ASC 840 for minimum fixed rentals under operating leases that have initial or remaining terms in excess of one year at March 31, 2019, was as follows:
Fiscal year | Operating Leases | |||||||
(in millions) | Real Estate | Equipment | ||||||
2020 | $ | $ | ||||||
2021 | ||||||||
2022 | ||||||||
2023 | ||||||||
2024 | ||||||||
Thereafter | ||||||||
Minimum fixed rentals | ||||||||
Less: sublease rental income | ( | ) | ||||||
Total rental payments | $ | $ | ||||||
Prior to fiscal 2020, required disclosure under ASC 840 for future minimum lease payments to be made under finance leases as of March 31, 2019, was as follows:
Fiscal year | ||||
(in millions) | Finance Leases | |||
2020 | $ | |||
2021 | ||||
2022 | ||||
2023 | ||||
2024 | ||||
Thereafter | ||||
Total minimum lease payments | ||||
Less: Amount representing interest and executory costs | ( | ) | ||
Present value of net minimum lease payments | $ | |||
24
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 8 - Fair Value
Fair Value Measurements on a Recurring Basis
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis, excluding pension assets and derivative assets and liabilities. See Note 9 - "Derivative and Hedging Activities" for information about the fair value of the Company's derivative assets and liabilities. There were no transfers between any of the levels during the periods presented.
Fair Value Hierarchy | ||||||||||||||||
(in millions) | December 31, 2019 | |||||||||||||||
Assets: | Fair Value | Level 1 | Level 2 | Level 3 | ||||||||||||
Money market funds and money market deposit accounts | $ | $ | $ | $ | ||||||||||||
Time deposits(1) | ||||||||||||||||
Other debt securities(2) | ||||||||||||||||
Deferred purchase price receivable | ||||||||||||||||
Total assets | $ | $ | $ | $ | ||||||||||||
Liabilities: | ||||||||||||||||
Contingent consideration | $ | $ | $ | $ | ||||||||||||
Total liabilities | $ | $ | $ | $ | ||||||||||||
March 31, 2019 | ||||||||||||||||
Assets: | Fair Value | Level 1 | Level 2 | Level 3 | ||||||||||||
Money market funds and money market deposit accounts | $ | $ | $ | $ | ||||||||||||
Time deposits(1) | ||||||||||||||||
Other debt securities(2) | ||||||||||||||||
Deferred purchase price receivable | ||||||||||||||||
Total assets | $ | $ | $ | $ | ||||||||||||
Liabilities: | ||||||||||||||||
Contingent consideration | $ | $ | $ | $ | ||||||||||||
Total liabilities | $ | $ | $ | $ | ||||||||||||
(1) Cost basis approximated fair value due to the short period of time to maturity.
(2) Other debt securities include available-for-sale investments with Level 2 inputs that have a cost basis of $38 million and $38 million, and unrealized gains of $13 million and $11 million, as of December 31, 2019 and March 31, 2019, respectively.
The fair value of money market funds, money market deposit accounts, and time deposits, included in cash and cash equivalents, are based on quoted market prices. The fair value of other debt securities, included in other long-term assets, is based on actual market prices. Fair value of the DPP, included in receivables, net, is determined by calculating the expected amount of cash to be received and is principally based on unobservable inputs consisting primarily of the face amount of the receivables adjusted for anticipated credit losses. The fair value of contingent consideration, included in other liabilities, is based on contractually defined targets of financial performance and other considerations.
25
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Other Fair Value Disclosures
The carrying amounts of the Company’s financial instruments with short-term maturities, primarily accounts receivable, accounts payable, short-term debt, and financial liabilities included in other accrued liabilities, are deemed to approximate their market values due to their short-term nature. If measured at fair value, these financial instruments would be classified in Level 2 or Level 3 of the fair value hierarchy.
The Company estimates the fair value of its long-term debt, primarily by using quoted prices obtained from third party providers such as Bloomberg, and by using an expected present value technique that is based on observable market inputs for instruments with similar terms currently available to the Company. The estimated fair value of the Company's long-term debt, excluding finance lease liabilities, was $7.1 billion and $5.6 billion as of December 31, 2019 and March 31, 2019, respectively, as compared with carrying value of $7.0 billion and $5.6 billion as of December 31, 2019 and March 31, 2019, respectively. If measured at fair value, long-term debt, excluding finance lease liabilities would be classified in Level 1 or Level 2 of the fair value hierarchy.
Non-financial assets such as goodwill, tangible assets, intangible assets and other contract related long-lived assets are recorded at fair value in the period they are initially recognized, and such fair value may be adjusted in subsequent periods if an event occurs or circumstances change that indicate that the asset may be impaired. The fair value measurements, in such instances, would be classified in Level 3. Other than the goodwill impairment losses discussed in Note 11 - "Goodwill," there were no significant impairments recorded during the fiscal periods covered by this report.
26
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 9 - Derivative and Hedging Activities
In the normal course of business, the Company is exposed to interest rate and foreign exchange rate fluctuations. As part of its risk management strategy, the Company uses derivative instruments, primarily foreign currency forward contracts and interest rate swaps, to hedge certain foreign currency and interest rate exposures. The Company’s objective is to reduce earnings volatility by offsetting gains and losses resulting from these exposures with losses and gains on the derivative contracts used to hedge them. The Company does not use derivative instruments for trading or any speculative purpose.
Derivatives Designated for Hedge Accounting
Cash flow hedges
The Company has designated certain foreign currency forward contracts as cash flow hedges to reduce foreign currency risk related to certain Indian Rupee, Euro and British Pound-denominated intercompany obligations and forecasted transactions. The notional amounts of foreign currency forward contracts designated as cash flow hedges as of December 31, 2019 and March 31, 2019 was $556 million and $277 million, respectively. As of December 31, 2019, the related forecasted transactions extend through June 2021.
For the three and nine months ended December 31, 2019 and December 31, 2018, the Company performed an assessment at the inception of the cash flow hedge transactions and determined all critical terms of the hedging instruments and hedged items matched. The Company performs an assessment of critical terms on an on-going basis throughout the hedging period. During the three and nine months ended December 31, 2019 and December 31, 2018, the Company had no cash flow hedges for which it was probable that the hedged transaction would not occur. As of December 31, 2019, $5 million of the existing amount of loss related to the cash flow hedge reported in AOCI is expected to be reclassified into earnings within the next 12 months.
Net investment hedges
During fiscal 2019, the Company designated certain foreign currency forward contracts as net investment hedges. These contracts were de-designated and settled during the nine months ended December 31, 2019, and as of December 31, 2019, there were no ne outstanding. As of December 31, 2018, there were no foreign currency forward contracts designated as net investment hedges.
The pre-tax gain (loss) on derivatives designated for hedge accounting recognized in income from continuing operations was $(1 ) million and $2 million for the three and nine months ended December 31, 2019. The pre-tax loss on derivatives designated for hedge accounting recognized in other comprehensive loss was $10 million and $21 million for the three and nine months ended December 31, 2019, respectively.
Derivatives Not Designated for Hedge Accounting
The derivative instruments not designated as hedges for purposes of hedge accounting include certain short-term foreign currency forward contracts. Derivatives that are not designated as hedging instruments are adjusted to fair value through earnings in the financial statement line item to which the derivative relates.
Foreign currency forward contracts
The Company manages the exposure to fluctuations in foreign currencies by using short-term foreign currency forward contracts to hedge certain foreign currency denominated assets and liabilities, including intercompany accounts and forecasted transactions. The notional amount of the foreign currency forward contracts outstanding as of December 31, 2019 and March 31, 2019 were $2.2 billion and $2.5 billion, respectively.
27
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
The following table presents the pretax amounts impacting income related to foreign currency forward contracts:
For the Three Months Ended | For the Nine Months Ended | |||||||||||||||||
(in millions) | Statement of Operations Line Item | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | |||||||||||||
Foreign currency forward contracts | Other expense (income), net | $ | $ | $ | ( | ) | $ | |||||||||||
Fair Value of Derivative Instruments
All derivative instruments are recorded at fair value. The Company’s accounting treatment for these derivative instruments is based on its hedge designation. The following tables present the fair values of derivative instruments included in the balance sheets:
Derivative Assets | ||||||||||
As of | ||||||||||
(in millions) | Balance Sheet Line Item | December 31, 2019 | March 31, 2019 | |||||||
Derivatives designated for hedge accounting: | ||||||||||
Foreign currency forward contracts | Other current assets | $ | $ | |||||||
Total fair value of derivatives designated for hedge accounting | $ | $ | ||||||||
Derivatives not designated for hedge accounting: | ||||||||||
Foreign currency forward contracts | Other current assets | $ | $ | |||||||
Total fair value of derivatives not designated for hedge accounting | $ | $ | ||||||||
Derivative Liabilities | ||||||||||
As of | ||||||||||
(in millions) | Balance Sheet Line Item | December 31, 2019 | March 31, 2019 | |||||||
Derivatives designated for hedge accounting: | ||||||||||
Foreign currency forward contracts | Accrued expenses and other current liabilities | $ | $ | |||||||
Total fair value of derivatives designated for hedge accounting: | $ | $ | ||||||||
Derivatives not designated for hedge accounting: | ||||||||||
Foreign currency forward contracts | Accrued expenses and other current liabilities | $ | $ | |||||||
Total fair value of derivatives not designated for hedge accounting | $ | $ | ||||||||
The fair value of foreign currency forward contracts represents the estimated amount required to settle the contracts using current market exchange rates and is based on the period-end foreign currency exchange rates and forward points which are classified as Level 2 inputs.
28
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Other Risks for Derivative Instruments
The Company is exposed to the risk of losses in the event of non-performance by the counterparties to its derivative contracts. The amount subject to credit risk related to derivative instruments is generally limited to the amount, if any, by which a counterparty's obligations exceed the obligations of the Company with that counterparty. To mitigate counterparty credit risk, the Company regularly reviews its credit exposure and the creditworthiness of the counterparties. With respect to its foreign currency derivatives, as of December 31, 2019, there were no counterparties with a concentration of credit risk.
The Company also enters into enforceable master netting arrangements with some of its counterparties. However, for financial reporting purposes, it is the Company's policy not to offset derivative assets and liabilities despite the existence of enforceable master netting arrangements. The potential effect of such netting arrangements on the Company's balance sheets is not material for the periods presented.
Non-Derivative Financial Instruments Designated for Hedge Accounting
The Company applies hedge accounting for foreign currency-denominated debt used to manage foreign currency exposures on its net investments in certain non-U.S. operations. To qualify for hedge accounting, the hedging instrument must be highly effective at reducing the risk from the exposure being hedged.
Net Investment Hedges
DXC seeks to reduce the impact of fluctuations in foreign exchange rates on its net investments in certain non-U.S. operations with foreign currency-denominated debt. For foreign currency denominated debt designated as a hedge, the effectiveness of the hedge is assessed based on changes in spot rates. For qualifying net investment hedges, all gains or losses on the hedging instruments are included in currency translation. Gains or losses on individual net investments in non-U.S. operations are reclassified to earnings from accumulated other comprehensive (loss) income when such net investments are sold or substantially liquidated.
29
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 10 - Intangible Assets
Intangible assets consisted of the following:
As of December 31, 2019 | ||||||||||||
(in millions) | Gross Carrying Value | Accumulated Amortization | Net Carrying Value | |||||||||
Software | $ | $ | $ | |||||||||
Customer related intangible assets | ||||||||||||
Other intangible assets | ||||||||||||
Total intangible assets | $ | $ | $ | |||||||||
As of March 31, 2019 | ||||||||||||
(in millions) | Gross Carrying Value | Accumulated Amortization | Net Carrying Value | |||||||||
Software | $ | $ | $ | |||||||||
Customer related intangible assets | ||||||||||||
Other intangible assets | ||||||||||||
Total intangible assets | $ | $ | $ | |||||||||
The components of amortization expense were as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||
Intangible asset amortization | $ | $ | $ | $ | ||||||||||||
Transition and transformation contract cost amortization(1) | ||||||||||||||||
Total amortization expense | $ | $ | $ | $ | ||||||||||||
(1) | Transaction and transformation contract costs are included within other assets on the balance sheet. |
Estimated future amortization related to intangible assets as of December 31, 2019 is as follows:
Fiscal Year | (in millions) | |||
Remainder of 2020 | $ | |||
2021 | $ | |||
2022 | $ | |||
2023 | $ | |||
2024 | $ | |||
30
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 11 - Goodwill
The following table summarizes the changes in the carrying amount of goodwill, by segment, as of December 31, 2019.
(in millions) | GBS | GIS | Total | |||||||||
Goodwill, gross | $ | $ | $ | |||||||||
Accumulated impairment losses | ( | ) | ( | ) | ( | ) | ||||||
Balance as of March 31, 2019, net | $ | $ | $ | |||||||||
Acquisitions | ||||||||||||
Foreign currency translation | ||||||||||||
Impairment losses(1) | ( | ) | ( | ) | ( | ) | ||||||
Goodwill, gross | ||||||||||||
Accumulated impairment losses | ( | ) | ( | ) | ( | ) | ||||||
Balance as of December 31, 2019, net | $ | $ | $ | |||||||||
(1) While preparing the fiscal 2020 third quarter financial statements, DXC recorded out-of-period corrections for previously unrecognized tax effects on tax deductible goodwill balances impaired during the fiscal 2020 second quarter. As a result, the balance sheet at December 31, 2019 includes reclassifications to reduce goodwill and increase deferred income taxes by $53 million. The income statement for the fiscal 2020 third quarter includes reclassifications that increase goodwill impairment losses and increase income tax benefit by $53 million. Based on an analysis of quantitative and qualitative factors, DXC determined that the out-of-period corrections are immaterial to the prior reporting periods affected.
The additions to goodwill were due to the acquisitions described in Note 3 - "Acquisitions" including goodwill of some insignificant acquisitions. The foreign currency translation amount reflects the impact of currency movements on non-U.S. dollar-denominated goodwill balances.
Goodwill Impairment Analyses
The Company tests goodwill for impairment on an annual basis, as of the first day of the second fiscal quarter, and between annual tests if circumstances change, or if an event occurs that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
The Company performed its annual goodwill impairment assessment as of July 1, 2019. Subsequent to the measurement date, the Company experienced a decline in its stock price and market capitalization that represented an indicator of impairment as the observed declines were substantial and sustained. As a result, the Company performed a quantitative goodwill impairment test for all of its reporting units, consistent with its policy described in Note 1 - "Summary of Significant Accounting Policies.” As part of the reconciliation to the Company’s market capitalization, the Company concluded that the carrying values of its reporting units exceeded their estimated fair values and recognized a non-cash impairment charge of $2,940 million, consisting of $2,675 million and $265 million in its GBS and GIS segments, respectively. Further declines in DXC’s share price or other impairment indicators could result in additional impairment charges in the future. The goodwill impairment charge does not have an impact on the calculation of the Company's financial covenants under the Company's debt arrangements.
31
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 12 - Debt
The following is a summary of the Company's debt:
(in millions) | Interest Rates | Fiscal Year Maturities | December 31, 2019 | March 31, 2019 | ||||||||
Short-term debt and current maturities of long-term debt | ||||||||||||
Commercial paper(1) | (0.23)% - 2.76% | 2020 | $ | $ | ||||||||
Current maturities of long-term debt | Various | 2020 - 2021 | ||||||||||
Current maturities of finance lease liabilities | .62% - 17.68% | 2020 - 2021 | ||||||||||
Short-term debt and current maturities of long-term debt | $ | $ | ||||||||||
Long-term debt, net of current maturities | ||||||||||||
AUD term loan | 1.68% - 2.66%(2) | 2022 | ||||||||||
GBP term loan | 1.57 - 1.63%(3) | 2022 | ||||||||||
EUR term loan | 0.65%(4) | 2022 | ||||||||||
EUR term loan | 0.80%(5) | 2023 | ||||||||||
USD term loan | 2.95% - 3.67%(6) | 2025 | ||||||||||
$500 million Senior notes | 2020 | |||||||||||
$500 million Senior notes | 3.08% - 3.69% | 2021 | ||||||||||
$274 million Senior notes | 2023 | |||||||||||
$171 million Senior notes | 2023 | |||||||||||
$500 million Senior notes | 2025 | |||||||||||
£250 million Senior notes | 2025 | |||||||||||
€650 million Senior notes | 2026 | |||||||||||
$500 million Senior notes | 2028 | |||||||||||
$234 million Senior notes | 2030 | |||||||||||
Lease credit facility | 2.70% - 3.50% | 2020 - 2023 | ||||||||||
Finance lease liabilities | .62% - 17.68% | 2020 - 2025 | ||||||||||
Borrowings for assets acquired under long-term financing | 0.38% - 5.78% | 2020 - 2026 | ||||||||||
Mandatorily redeemable preferred stock outstanding | 2023 | |||||||||||
Other borrowings | 0.50% - 7.40% | 2020 - 2022 | ||||||||||
Long-term debt | ||||||||||||
Less: current maturities | ||||||||||||
Long-term debt, net of current maturities | $ | $ | ||||||||||
(1) | At DXC's option, DXC can borrow up to a maximum of € |
(2) Variable interest rate equal to the bank bill swap bid rate for a one-, two-, three- or six-month interest period plus 0.60 % to 0.95 % based on the published credit ratings of DXC.
(3) Three-month LIBOR rate plus 0.80 %.
(4) At DXC's option, the EUR term loan bears interest at the Eurocurrency Rate for a one-, two-, three-, or six-month interest period, plus a margin between 0.40 % and 0.9 %, based on published credit ratings of DXC.
(5) At DXC's option, the EUR term loan bears interest at the Eurocurrency Rate for a one-, two-, three-, or six-month interest period, plus a margin between 0.55 % and 1.05 %, based on published credit ratings of DXC.
(6) At DXC's option, the USD term loan bears interest at the Eurocurrency Rate for a one-, two-, three-, or six-month interest period, plus a margin between 1.00 % and 1.50 %, based on published credit ratings of DXC or the Base Rate plus a margin between 0.00 % and 0.50 %, based on published credit ratings of DXC.
32
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Senior Notes and Term Loans
Interest on the Company's term loans is payable monthly or quarterly in arrears at the election of the borrowers. The Company fully and unconditionally guarantees term loans issued by its 100% owned subsidiaries. Interest on the Company's senior notes is payable semi-annually in arrears, except for interest on the £250 million Senior Notes due 2025 and the €650 million Senior Notes due 2026 which are payable annually in arrears. Generally, the Company's notes are redeemable at the Company's discretion at the then-applicable redemption premium plus accrued interest.
Note 13 - Revenue
Revenue Recognition
The following table presents our revenues disaggregated by geography, based on the location of incorporation of the DXC entity providing the related goods or services:
Three Months Ended | Nine Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||
United States | $ | $ | $ | $ | ||||||||||||
United Kingdom | ||||||||||||||||
Australia | ||||||||||||||||
Other Europe | ||||||||||||||||
Other International | ||||||||||||||||
Total Revenues | $ | $ | $ | $ | ||||||||||||
The revenue by geography pertains to both of the Company’s reportable segments. Refer to Note 20 - "Segment Information" for the Company’s segment disclosures.
Remaining Performance Obligations
Remaining performance obligations represent the aggregate amount of the transaction price in contracts allocated to performance obligations not delivered, or partially undelivered, as of the end of the reporting period. Remaining performance obligation estimates are subject to change and are affected by several factors, including terminations, changes in the scope of contracts, periodic revalidations, adjustments for revenue that has not materialized and adjustments for currency. As of December 31, 2019, approximately $25.6 billion of revenue is expected to be recognized from remaining performance obligations. We expect to recognize revenue on approximately 15 % of these remaining performance obligations in fiscal 2020, with the remainder of the balance recognized thereafter.
Contract Balances
The following table provides information about the balances of the Company's trade receivables and contract assets and contract liabilities:
As of | ||||||||
(in millions) | December 31, 2019 | March 31, 2019 | ||||||
Trade receivables, net | $ | $ | ||||||
Contract assets | $ | $ | ||||||
Contract liabilities | $ | $ | ||||||
33
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Change in contract liabilities were as follows:
(in millions) | Nine Months Ended December 31, 2019 | |||
Balance, beginning of period | $ | |||
Deferred revenue | ||||
Recognition of deferred revenue | ( | ) | ||
Currency translation adjustment | ||||
Other | ( | ) | ||
Balance, end of period | $ | |||
Note 14 - Restructuring Costs
The Company recorded restructuring costs of $74 million and $76 million, net of reversals, for the three months ended December 31, 2019 and December 31, 2018, respectively. For the nine months ended December 31, 2019 and December 31, 2018, the Company recorded restructuring costs of $248 million and $418 million, net of reversals, respectively. The costs recorded during the three and nine months ended December 31, 2019 were largely a result of the Fiscal 2020 Plan (defined below).
The composition of restructuring liabilities by financial statement line item is as follows:
As of | ||||
(in millions) | December 31, 2019 | |||
Accrued expenses and other current liabilities | $ | |||
Other long-term liabilities | ||||
Total | $ | |||
Summary of Restructuring Plans
Fiscal 2020 Plan
During fiscal 2020, management approved cost savings initiatives designed to reduce operating costs by re-balancing its workforce and facilities structures (the "Fiscal 2020 Plan"). The Fiscal 2020 Plan includes workforce optimization programs and facilities and data center rationalization.
Fiscal 2019 Plan
During fiscal 2019, management approved global cost savings initiatives designed to better align the Company's organizational structure with its strategic initiatives and continue the integration of the Enterprise Services business of Hewlett Packard Enterprise Company ("HPES") and other acquisitions (the "Fiscal 2019 Plan"). The Fiscal 2019 Plan includes workforce optimization and rationalization of facilities and data center assets. Costs incurred to date under the Fiscal 2019 Plan total $491 million, comprising $348 million in employee severance and $143 million of facilities costs.
34
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Fiscal 2018 Plan
In June 2017, management approved a post-HPES Merger (as defined below) restructuring plan to optimize the Company's operations in response to a continuing business contraction (the "Fiscal 2018 Plan"). The Fiscal 2018 Plan focuses mainly on optimizing specific aspects of global workforce, increasing the proportion of work performed in low cost offshore locations and re-balancing the pyramid structure. Additionally, this plan included global facility restructuring, including a global data center restructuring program. Costs incurred to date under the Fiscal 2018 Plan total $774 million, comprising $587 million in employee severance and $187 million of facilities costs.
Other Prior Year Plans
In May 2016, the Company initiated a restructuring plan to realign the Company's cost structure and resources to take advantage of operational efficiencies following recent acquisitions. During the fourth quarter of fiscal 2017, the Company expanded the plan to strengthen the Company's competitiveness and to optimize the workforce by increasing work performed in low-cost locations (the "Fiscal 2017 Plan"). Costs incurred to date under the Fiscal 2017 Plan total $215 million, comprising $206 million in employee severance and $9 million of facilities costs.
Acquired Restructuring Liabilities
As a result of the merger of Computer Sciences Corporation ("CSC") and HPES ("HPES Merger"), DXC acquired restructuring liabilities under restructuring plans that were initiated for HPES under plans approved by the HPE Board of Directors.
35
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Restructuring Liability Reconciliations by Plan
Restructuring Liability as of March 31, 2019 | Adoption of ASC 842(1) | Costs Expensed, Net of Reversals(2) | Costs Not Affecting Restructuring Liability(3) | Cash Paid | Other(4) | Restructuring Liability as of December 31, 2019 | ||||||||||||||||||||||
Fiscal 2020 Plan | ||||||||||||||||||||||||||||
Workforce Reductions | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | |||||||||||||||||
Facilities Costs | ( | ) | ( | ) | ||||||||||||||||||||||||
Total | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | $ | |||||||||||||||||
Fiscal 2019 Plan | ||||||||||||||||||||||||||||
Workforce Reductions | $ | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | |||||||||||||||
Facilities Costs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||
Total | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | $ | |||||||||||||
Fiscal 2018 Plan | ||||||||||||||||||||||||||||
Workforce Reductions | $ | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | |||||||||||||||||
Facilities Costs | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||
Total | $ | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | $ | $ | |||||||||||||||
Other Prior Year Plans | ||||||||||||||||||||||||||||
Workforce Reductions | $ | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | |||||||||||||||||
Facilities Costs | ( | ) | ||||||||||||||||||||||||||
Total | $ | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | $ | $ | |||||||||||||||
Acquired Liabilities | ||||||||||||||||||||||||||||
Workforce Reductions | $ | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | |||||||||||||||||
Facilities Costs | $ | ( | ) | ( | ) | ( | ) | |||||||||||||||||||||
Total | $ | $ | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | $ | |||||||||||||||
(1) Represents restructuring liability recorded as an offset to right-of-use assets upon the adoption of ASC 842.
(2) Costs expensed, net of reversals include $19 million, $10 million, and $3 million of costs reversed from the Fiscal 2019 Plan, Fiscal 2018 Plan and Other Prior Year Plans, respectively.
(3) Pension benefit augmentations recorded as a pension liability, asset impairments and restructuring costs associated with right-of-use assets.
(4)Foreign currency translation adjustments.
36
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 15 - Pension and Other Benefit Plans
The Company offers a number of pension and other post-retirement benefit ("OPEB") plans, life insurance benefits, deferred compensation and defined contribution plans. Most of the Company's pension plans are not admitting new participants; therefore, changes to pension liabilities are primarily due to market fluctuations of investments for existing participants and changes in interest rates.
Defined Benefit Plans
The Company sponsors a number of defined benefit and post-retirement medical benefit plans for the benefit of eligible employees. The benefit obligations of the Company's U.S. pension, U.S. OPEB, and non-U.S. OPEB represent an insignificant portion of the Company's pension and other post-retirement benefits. As a result, the disclosures below include the Company's U.S. and non-U.S. pension plans on a global consolidated basis.
The Company contributed $39 million and $71 million to the defined benefit pension and OPEB plans during the three and nine months ended December 31, 2019, respectively. The Company expects to contribute an additional $32 million during the remainder of fiscal 2020, which does not include certain salary deferral programs and future potential termination benefits related to the Company's potential restructuring activities.
During the three and nine months ended December 31, 2019, the Company accrued $0 million and $17 million, respectively, of additional contractual termination benefits for certain employees as part of restructuring plans (see Note 14 - "Restructuring Costs"). These amounts are reflected in the projected benefit obligation and in the net periodic pension cost.
The components of net periodic pension income were:
Three Months Ended | Nine Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||
Service cost | $ | $ | $ | $ | ||||||||||||
Interest cost | ||||||||||||||||
Expected return on assets | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Amortization of prior service costs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Contractual termination benefit | ||||||||||||||||
Curtailment gain | ( | ) | ||||||||||||||
Net periodic pension income | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||
The service cost component of net periodic pension income is presented in cost of services and selling, general and administrative and the other components of net periodic pension income are presented in other income, net, except for contractual termination benefit which is included in restructuring, in the Company’s statements of operations.
The weighted-average rates used to determine net periodic pension cost for the three and nine months ended December 31, 2019 and December 31, 2018 were:
December 31, 2019 | December 31, 2018 | |||||
Discount or settlement rates | % | % | ||||
Expected long-term rates of return on assets | % | % | ||||
Rates of increase in compensation levels | % | % | ||||
37
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Deferred Compensation Plans
Effective as of the HPES Merger, DXC assumed sponsorship of the Computer Sciences Corporation Deferred Compensation Plan, which was renamed the “DXC Technology Company Deferred Compensation Plan” (the “DXC DCP”) and adopted the Enterprise Services Executive Deferred Compensation Plan (the “ES DCP”). Both plans are non-qualified deferred compensation plans maintained for a select group of management, highly compensated employees and non-employee directors.
The DXC DCP covers eligible employees who participated in CSC’s Deferred Compensation Plan prior to the HPES Merger. The ES DCP covers eligible employees who participated in the HPE Executive Deferred Compensation Plan prior to the HPES Merger. Both plans allow participating employees to defer the receipt of current compensation to a future distribution date or event above the amounts that may be deferred under DXC’s tax-qualified 401(k) plan, the DXC Technology Matched Asset Plan. Neither plan provides for employer contributions. As of April 3, 2017, the ES DCP does not admit new participants.
Note 16 - Income Taxes
The Company's effective tax rate from continuing operations ("ETR") was 29.1 % and 0.6 % for the three months ended December 31, 2019 and December 31, 2018, respectively, and (11.5 )% and 17.7 % for the nine months ended December 31, 2019 and December 31, 2018, respectively. For the three months ended December 31, 2019, the primary drivers of the ETR were the impact of previously unrecognized tax effects on the tax deductible goodwill impaired during the fiscal 2020 second quarter, the global mix of income, an increase in prior year U.S. federal research and development income tax credits, and an increase in unrecognized tax benefits primarily related to audit activity. For the nine months ended December 31, 2019, the primary drivers of the ETR were the impact of the non-deductible goodwill impairment charge, the non-taxable gain on the arbitration award, the global mix of income, an increase in unrecognized tax benefits primarily related to audit activity, and an increase in prior year U.S. federal research and development income tax credits, net. For the three months ended December 31, 2018, the primary drivers of the effective tax rate ("ETR") were the global mix of income, the net decrease in valuation allowances on certain foreign deferred tax assets, and the decrease in transition tax liability. For the nine months ended December 31, 2018, the primary drivers of the ETR were the global mix of income, the net decrease in valuation allowances on certain foreign deferred tax assets, the decrease in transition tax liability, the filing of the October 31, 2017 U.S. federal tax return and the impact of U.S. proposed regulations on the ability to claim certain foreign tax credits.
The tax expense associated with discontinued operations for the nine months ended December 31, 2019 was $0 million as compared to $18 million during the same period of the prior fiscal year. The primary driver of the variance in the tax expense for the nine months ended December 31, 2019 and December 31, 2018 was the difference in income before tax for the respective periods.
As the result of the issuance of new U.S. Treasury regulations in the first quarter of fiscal 2020, the Company changed its permanent reinvestment assertion in the first quarter of fiscal 2020 with respect to certain foreign corporations, reducing the amount that will ultimately be repatriated to the U.S. by approximately $498 million. With the exception of this change, DXC's prior permanent reinvestment assertion, that the Company will repatriate all current and accumulated earnings for all non-U.S. subsidiaries other than India, continues to apply. DXC does not believe this assertion change will have an adverse effect on the Company as U.S. cash needs will be satisfied from other sources of non-U.S. earnings.
38
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
In connection with the Separation of USPS, the Company entered into a tax matters agreement with Perspecta. Pursuant to the tax matters agreement, the Company generally will be responsible for tax liabilities arising prior to the Separation of USPS. Income tax liabilities transferred to Perspecta primarily relate to pre-HPES Merger periods, for which the Company is indemnified by HPE pursuant to the tax matters agreement between the Company and HPE. The Company is also liable to HPE for tax receivables and refunds which it receives from Perspecta related to pre-HPES Merger periods that were transferred to Perspecta. Pursuant to the tax matters agreement with Perspecta, the Company has recorded a tax indemnification receivable from Perspecta of $77 million and a tax indemnification payable to Perspecta of $64 million related to income tax and other tax liabilities. As a result of the HPES Merger, the Company continues to have a net receivable of $18 million from HPE, comprised of a $107 million tax indemnification receivable related to tax payables, a $43 million tax indemnification receivable related to uncertain tax positions (net of related deferred tax benefits), and $132 million of tax indemnification payable related to other tax receivables.
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, the Company 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. The Company and the IRS Office of Appeals have an agreement in principle as to some, but not all of these adjustments.
The Company has agreed to extend the statute of limitations associated with this audit through June 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. The Company expects to reach a resolution for all years no earlier than the fourth quarter of fiscal 2021 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, 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 for unrecognized tax benefits. In the third quarter of fiscal 2020 the Company’s liability for uncertain tax positions increased by $20 million (excluding interest and penalties and related tax attributes) largely due to additions for U.S. federal research and development credits and certain audits. 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 by payment with the tax authorities for amounts lower than those that have been accrued or extinguish a position through payment. The Company believes the outcomes that are reasonably possible within the next 12 months may result in a reduction in liability for uncertain tax positions of $25 million to $28 million, excluding interest, penalties and tax carry-forwards.
Note 17 - Stockholders' Equity
Share Repurchases
On April 3, 2017, DXC announced the establishment of a share repurchase program approved by the Board of Directors with an initial authorization of $2.0 billion for future repurchases of outstanding shares of DXC common stock. On November 8, 2018, DXC's Board of Directors approved an incremental $2.0 billion share repurchase authorization. An expiration date has not been established for this repurchase plan. Share repurchases may be made from time to time through various means, including in open market purchases, 10b5-1 plans, privately-negotiated transactions, accelerated stock repurchases, block trades and other transactions, in compliance with Rule 10b-18 under the Exchange Act as well as, to the extent applicable, other federal and state securities laws and other legal requirements. The timing, volume, and nature of share repurchases pursuant to the share repurchase plan are at the discretion of management and may be suspended or discontinued at any time.
39
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
As part of the share repurchase program, during the first quarter of fiscal 2020, DXC entered into an accelerated share repurchase ("ASR") agreement with a third-party financial institution by advancing $200 million including a $100 million prepayment. At inception, the ASR was initially settled by delivery of 1,849,194 shares of common stock to the Company. During the second quarter of fiscal 2020, DXC received an additional 1,805,350 shares of common stock. In total, 3,654,544 shares of common stock were repurchased under the ASR for $200 million, resulting in an average price paid of $54.73 per share.
The shares repurchased are retired immediately and included in the category of authorized but unissued shares. The excess of purchase price over par value of the common shares is allocated between additional paid-in capital and retained earnings. The details of shares repurchased are shown below:
Fiscal 2020 | Fiscal 2019 | |||||||||||||||||||||
Fiscal Period | Number of Shares Repurchased | Average Price Per Share | Amount (in millions) | Number of Shares Repurchased | Average Price Per Share | Amount (in millions) | ||||||||||||||||
1st Quarter | ||||||||||||||||||||||
Open market purchases | $ | $ | $ | $ | ||||||||||||||||||
ASR | ||||||||||||||||||||||
1st Quarter Total | ||||||||||||||||||||||
2nd Quarter | ||||||||||||||||||||||
Open market purchases | ||||||||||||||||||||||
ASR | ||||||||||||||||||||||
2nd Quarter Total | ||||||||||||||||||||||
3rd Quarter | ||||||||||||||||||||||
Open market purchases | ||||||||||||||||||||||
ASR | ||||||||||||||||||||||
3rd Quarter Total | ||||||||||||||||||||||
Total | $ | $ | $ | $ | ||||||||||||||||||
Accumulated Other Comprehensive Income (Loss)
The following table shows the changes in accumulated other comprehensive income (loss), net of taxes:
(in millions) | Foreign Currency Translation Adjustments | Cash Flow Hedges | Available-for-sale Securities | Pension and Other Post-retirement Benefit Plans | Accumulated Other Comprehensive (Loss) Income | |||||||||||||||
Balance at March 31, 2019 | $ | ( | ) | $ | ( | ) | $ | $ | $ | ( | ) | |||||||||
Current-period other comprehensive loss | ( | ) | ||||||||||||||||||
Amounts reclassified from accumulated other comprehensive income (loss) | ( | ) | ( | ) | ( | ) | ||||||||||||||
Balance at December 31, 2019 | $ | ( | ) | $ | ( | ) | $ | $ | $ | ( | ) | |||||||||
40
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
(in millions) | Foreign Currency Translation Adjustments | Cash Flow Hedges | Available-for-sale Securities | Pension and Other Post-retirement Benefit Plans | Accumulated Other Comprehensive Income (Loss) | |||||||||||||||
Balance at March 31, 2018 | $ | ( | ) | $ | $ | $ | $ | |||||||||||||
Current-period other comprehensive loss | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||
Amounts reclassified from accumulated other comprehensive loss | ( | ) | ( | ) | ||||||||||||||||
Balance at December 31, 2018 | $ | ( | ) | $ | ( | ) | $ | $ | $ | ( | ) | |||||||||
Note 18 - Stock Incentive Plans
Equity Plans
The Compensation Committee of the Board of Directors (the "Board") has broad authority to grant awards and otherwise administer the DXC Employee Equity Plan. The plan became effective March 30, 2017 and will continue in effect for a period of 10 years thereafter, unless earlier terminated by the Board. The Board has the authority to amend the plan in such respects as it deems desirable, subject to approval of DXC’s stockholders for material modifications.
RSUs represent the right to receive one share of DXC common stock upon a future settlement date, subject to vesting and other terms and conditions of the award, plus any dividend equivalents accrued during the award period. In general, if the employee’s status as a full-time employee is terminated prior to the vesting of the RSU grant in full, then the RSU grant is automatically canceled on the termination date and any unvested shares and dividend equivalents are forfeited. Certain executives were awarded service-based "career share" RSUs for which the shares are settled over the 10 anniversaries following the executive's separation from service as a full-time employee, provided the executive complies with certain non-competition covenants during that period.
The Company also grants PSUs, which generally vest over a period of 3 years. The number of PSUs that ultimately vest is dependent upon the Company’s achievement of certain specified financial performance criteria over a three-year period. If the specified performance criteria are met, awards are settled for shares of DXC common stock and dividend equivalents upon the filing with the SEC of the Annual Report on Form 10-K for the last fiscal year of the performance period. PSU awards include the potential for up to 25 % of the shares granted to be earned after the first and second fiscal years if certain of the Company's performance targets are met early, subject to vesting based on the participant's continued employment through the end of the three-year performance period.
The terms of the DXC Director Equity Plan allow DXC to grant RSU awards to non-employee directors of DXC. Such RSU awards vest in full at the earlier of (i) the first anniversary of the grant date or (ii) the next annual meeting date, and are automatically redeemed for DXC common stock and dividend equivalents either at that time or, if an RSU deferral election form is submitted, upon the date or event elected by the director. Distributions made upon a director’s separation from the Board may occur in either a lump sum or in annual installments over periods of 5 , 10 , or 15 years, per the director’s election. In addition, RSUs vest in full upon a change in control of DXC.
The DXC Share Purchase Plan allows DXC’s employees located in the United Kingdom to purchase shares of DXC’s common stock at the fair market value of such shares on the applicable purchase date. There were 7,939 and 18,420 shares purchased under this plan during the three and nine months ended December 31, 2019.
41
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
The Board has reserved for issuance shares of DXC common stock, par value $0.01 per share, under each of the plans as detailed below:
As of December 31, 2019 | ||||||
Reserved for Issuance | Available for Future Grants | |||||
DXC Employee Equity Plan | ||||||
DXC Director Equity Plan | ||||||
DXC Share Purchase Plan | ||||||
Total | ||||||
Stock Options
Number of Option Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value (in millions) | ||||||||||
Outstanding as of March 31, 2019 | $ | $ | |||||||||||
Granted | $ | ||||||||||||
Exercised | ( | ) | $ | $ | |||||||||
Canceled/Forfeited | ( | ) | $ | ||||||||||
Expired | ( | ) | $ | ||||||||||
Outstanding as of December 31, 2019 | $ | $ | |||||||||||
Vested and expected to vest in the future as of December 31, 2019 | $ | $ | |||||||||||
Exercisable as of December 31, 2019 | $ | $ | |||||||||||
Restricted Stock
Employee Equity Plan | Director Equity Plan | |||||||||||||
Number of Shares | Weighted Average Grant Date Fair Value | Number of Shares | Weighted Average Grant Date Fair Value | |||||||||||
Outstanding as of March 31, 2019 | $ | $ | ||||||||||||
Granted | $ | $ | ||||||||||||
Settled | ( | ) | $ | ( | ) | $ | ||||||||
Canceled/Forfeited | ( | ) | $ | $ | ||||||||||
Outstanding as of December 31, 2019 | $ | $ | ||||||||||||
42
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Share-Based Compensation
Three Months Ended | Nine Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||
Total share-based compensation cost | $ | $ | $ | $ | ||||||||||||
Related income tax benefit | $ | ( | ) | $ | $ | $ | ||||||||||
Total intrinsic value of options exercised | $ | $ | $ | $ | ||||||||||||
Tax benefits from exercised stock options and awards | $ | $ | $ | $ | ||||||||||||
As of December 31, 2019, total unrecognized compensation expense related to unvested DXC stock options and unvested DXC RSUs, net of expected forfeitures was $1 million and $140 million, respectively. The unrecognized compensation expense for unvested RSUs is expected to be recognized over a weighted-average period of 2.06 years.
Note 19 - Cash Flows
Cash payments for interest on indebtedness and income taxes and other select non-cash activities are as follows:
Nine Months Ended | ||||||||
(in millions) | December 31, 2019 | December 31, 2018 | ||||||
Cash paid for: | ||||||||
Interest | $ | $ | ||||||
Taxes on income, net of refunds (1) | $ | $ | ||||||
Non-cash activities: | ||||||||
Operating: | ||||||||
ROU assets obtained in exchange for lease, net (2) | $ | $ | ||||||
Prepaid assets acquired under long-term financing | $ | $ | ||||||
Investing: | ||||||||
Capital expenditures in accounts payable and accrued expenses | $ | $ | ||||||
Capital expenditures through finance lease obligations | $ | $ | ||||||
Assets acquired under long-term financing | $ | $ | ||||||
(Decrease) / increase in deferred purchase price receivable | $ | $ | ||||||
Contingent consideration | $ | $ | ||||||
Financing: | ||||||||
Dividends declared but not yet paid | $ | $ | ||||||
(1) Income tax refunds were $36 million and $166 million for the nine months ended December 31, 2019 and December 31, 2018, respectively.
(2) Net of $87 million change in lease classification from operating to finance lease.
43
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 20 - Segment Information
DXC has a matrix form of organization and is managed in several different and overlapping groupings including services, industry and geographic region. As a result and in accordance with accounting standards, operating segments are organized by the type of services provided. DXC's chief operating decision maker ("CODM"), the chief executive officer, obtains, reviews, and manages the Company’s financial performance based on these segments. The CODM uses these results, in part, to evaluate the performance of, and allocate resources to, each of the segments.
As a result of the Separation, USPS is no longer included as a reportable segment and its results have been reclassified to discontinued operations, net of taxes, for all periods presented. See Note 4 - "Divestitures". DXC now operates in two reportable segments as described below:
Global Business Services
GBS provides innovative technology solutions that help its clients address key business challenges and accelerate digital transformations tailored to each client’s industry and specific objectives. GBS offerings include:
• | Enterprise, Cloud Applications and Consulting. GBS provides industry, business process systems integration and technical delivery experience to maximize value from enterprise application portfolios. GBS also helps clients accelerate their digital transformations and business results with industry, business, technology and complex integration services. |
• | Application Services. GBS's comprehensive services helps clients modernize, develop, test and manage their applications. |
• | Analytics. GBS's portfolio of analytics services and robust partner ecosystem helps clients gain rapid insights and accelerate their digital transformation journeys. |
• | Business Process Services. GBS provides seamless digital integration and optimization of front and back office processes, including its Agile Process Automation approach. |
• | Industry Software and Solutions. GBS's industry-specific solutions enable businesses to quickly integrate technology, transform their operations and develop new ways of doing business. GBS's vertical-specific IP includes insurance, healthcare and life sciences, travel and transportation, and banking and capital markets solutions. |
Global Infrastructure Services
GIS provides a portfolio of offerings that deliver predictable outcomes and measurable results while reducing business risk and operational costs for clients. GIS offerings include:
• | Cloud and Platform Services. GIS helps clients maximize their private cloud, public cloud and legacy infrastructures, as well as securely manage their hybrid environments. |
• | Workplace and Mobility. GIS's workplace, mobility and Internet of Things ("IoT") services provides a consumer-like experience with enterprise security and instant connectivity for its clients. |
• | Security. GIS's security solutions help predict attacks, proactively respond to threats, ensure compliance and protect data, applications, infrastructure and endpoints. |
44
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Segment Measures
The following table summarizes operating results regularly provided to the CODM by reportable segment and a reconciliation to the financial statements:
(in millions) | GBS | GIS | Total Reportable Segments | All Other | Totals | |||||||||||||||
Three Months Ended December 31, 2019 | ||||||||||||||||||||
Revenues | $ | $ | $ | $ | $ | |||||||||||||||
Segment profit | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
Depreciation and amortization(1) | $ | $ | $ | $ | $ | |||||||||||||||
Three Months Ended December 31, 2018 | ||||||||||||||||||||
Revenues | $ | $ | $ | $ | $ | |||||||||||||||
Segment profit | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
Depreciation and amortization(1) | $ | $ | $ | $ | $ | |||||||||||||||
(in millions) | GBS | GIS | Total Reportable Segments | All Other | Totals | |||||||||||||||
Nine Months Ended December 31, 2019 | ||||||||||||||||||||
Revenues | $ | $ | $ | $ | $ | |||||||||||||||
Segment profit | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
Depreciation and amortization(1) | $ | $ | $ | $ | $ | |||||||||||||||
Nine Months Ended December 31, 2018 | ||||||||||||||||||||
Revenues | $ | $ | $ | $ | $ | |||||||||||||||
Segment profit | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
Depreciation and amortization(1) | $ | $ | $ | $ | $ | |||||||||||||||
(1) Depreciation and amortization as presented excludes amortization of acquired intangible assets of $146 million and $134 million for the three months ended December 31, 2019 and 2018, respectively, and $435 million and $401 million for the nine months ended December 31, 2019 and 2018 respectively.
45
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Reconciliation of Reportable Segment Profit to Consolidated Total
The Company's management uses segment profit as the measure for assessing performance of its segments. Segment profit is defined as segment revenue less costs of services, segment selling, general and administrative, depreciation and amortization, and other income (excluding the movement in foreign currency exchange rates on our foreign currency denominated assets and liabilities and the related economic hedges). The Company does not allocate to its segments certain operating expenses managed at the corporate level. These unallocated costs include certain corporate function costs, stock-based compensation expense, pension and OPEB actuarial and settlement gains and losses, restructuring costs, transaction, separation and integration-related costs and amortization of acquired intangible assets.
Three Months Ended | Nine Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||
Profit | ||||||||||||||||
Total profit for reportable segments | $ | $ | $ | |||||||||||||
All other loss | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Interest income | ||||||||||||||||
Interest expense | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Restructuring costs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Transaction, separation and integration-related costs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Amortization of acquired intangible assets | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Goodwill impairment losses | ( | ) | ( | ) | ||||||||||||
Gain on arbitration award | ||||||||||||||||
Income (loss) from continuing operations before income taxes | $ | $ | $ | ( | ) | $ | ||||||||||
46
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Note 21 - Commitments and Contingencies
Commitments
The Company signed long-term purchase agreements with certain software, hardware, telecommunication, and other service providers to obtain favorable pricing and terms for services, and products that are necessary for the operations of business activities. Under the terms of these agreements, the Company is contractually committed to purchase specified minimums over periods ranging from 1 to 6 years. If the Company does not meet the specified minimums, the
Company would have an obligation to pay the service provider all, or a portion, of the shortfall. Minimum purchase commitments as of December 31, 2019 were as follows:
Fiscal year | Minimum Purchase Commitment(1) | |||
(in millions) | ||||
Remainder of 2020 | $ | |||
2021 | ||||
2022 | ||||
2023 | ||||
2024 | ||||
Thereafter | ||||
Total | $ | |||
(1) A significant portion of the minimum purchase commitments for fiscal 2020 and fiscal 2021 relate to the amounts committed under the HPE preferred vendor agreements.
In the normal course of business, the Company may provide certain clients with financial performance guarantees, and at times performance letters of credit or surety bonds. In general, the Company would only be liable for the amounts of these guarantees in the event that non-performance by the Company permits termination of the related contract by the Company’s client. The Company believes it is in compliance with its performance obligations under all service contracts for which there is a financial performance guarantee, and the ultimate liability, if any, incurred in connection with these guarantees will not have a material adverse effect on its consolidated results of operations or financial position.
The Company also uses stand-by letters of credit, in lieu of cash, to support various risk management insurance policies. These letters of credit represent a contingent liability and the Company would only be liable if it defaults on its payment obligations on these policies. The following table summarizes the expiration of the Company’s financial guarantees and stand-by letters of credit outstanding as of December 31, 2019:
(in millions) | Fiscal 2020 | Fiscal 2021 | Fiscal 2022 and Thereafter | Totals | ||||||||||||
Surety bonds | $ | $ | $ | $ | ||||||||||||
Letters of credit | ||||||||||||||||
Stand-by letters of credit | ||||||||||||||||
Totals | $ | $ | $ | $ | ||||||||||||
The Company generally indemnifies licensees of its proprietary software products against claims brought by third parties alleging infringement of their intellectual property rights, including rights in patents (with or without geographic limitations), copyrights, trademarks, and trade secrets. DXC’s indemnification of its licensees relates to costs arising from court awards, negotiated settlements, and the related legal and internal costs of those licensees. The Company maintains the right, at its own cost, to modify or replace software in order to eliminate any infringement. The Company has not incurred any significant costs related to licensee software indemnification.
47
DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Contingencies
Vincent Forcier v. Computer Sciences Corporation and The City of New York: On October 27, 2014, the United States Attorney’s Office for the Southern District of New York and the Attorney General for the State of New York filed complaints-in-intervention on behalf of the United States and the State of New York, respectively, against CSC and The City of New York, based on a qui tam complaint originally filed under seal in 2012 by Vincent Forcier, a former employee of CSC. The complaints allege that from 2008 to 2012 New York City and CSC, in its role as fiscal agent for New York City’s Early Intervention Program ("EIP"), violated the federal and state False Claims Acts and various common law standards by allegedly orchestrating a billing fraud against Medicaid through the misapplication of default billing codes and the failure to exhaust private insurance coverage before submitting claims to Medicaid. The lawsuits seek treble statutory damages, other civil penalties and attorneys’ fees and costs.
In June 2016, the Court dismissed Forcier’s amended complaint in its entirety. With regard to the complaints-in-intervention, the Court dismissed the federal claims alleging misuse of default diagnosis codes when the provider had entered an invalid code, and the state claims alleging failure to reimburse Medicaid when claims were subsequently paid by private insurance. The Court allowed the remaining claims to proceed. In September 2016, the United States and the State of New York each filed amended complaints-in-intervention, asserting additional claims that the compensation provisions of CSC’s contract with New York City rendered it ineligible to serve as a billing agent under state law.
CSC filed motions to dismiss and in August 2017, the Court granted in part and denied in part CSC's motions. In January 2018, CSC asserted a counterclaim against the State of New York on a theory of contribution and indemnification. The court denied the State's motion to dismiss CSC's counterclaim with respect to liability for claims not arising under the Federal False Claims Act. The Parties participated in a non-binding mediation in November 2017. No settlement has been reached to date, but negotiations are ongoing. Discovery has now commenced. The Company believes that these claims are without merit and intends to continue to defend itself vigorously.
Strauch Fair Labor Standards Act Collective Action: On July 1, 2014, several plaintiffs filed an action in the U.S. District Court for the District of Connecticut on behalf of themselves and a putative nationwide collective of CSC system administrators, alleging CSC’s failure to properly classify these employees as non-exempt under the federal Fair Labor Standards Act ("FLSA"). Plaintiffs alleged similar state-law Rule 23 class claims pursuant to Connecticut and California statutes. Plaintiffs claimed double overtime damages, liquidated damages, and other amounts and remedies.
In 2015 the Court entered an order granting conditional certification under the FLSA of the collective of over 4,000 system administrators. Approximately 1,000 system administrators filed consents with the Court to participate in the FLSA collective. The class/collective action is currently made up of approximately 800 individuals who held the title of associate professional or professional system administrator.
In June 2017, the Court granted Rule 23 certification of a Connecticut state-law class and a California state-law class consisting of professional system administrators and associate professional system administrators. Senior professional system administrators were found not to qualify for Rule 23 certification under the state-law claims. CSC sought permission to appeal the Rule 23 decision to the Second Circuit Court of Appeals, which was denied.
In December 2017, a jury trial was held and a verdict was returned in favor of plaintiffs. On August 6, 2019, the Court issued an order awarding plaintiffs $18.75 million in damages. In September 2019, Plaintiffs filed a motion seeking $14.1 million in attorneys’ fees and costs. The Court has yet to rule on this motion. The Company disagrees with the jury verdict and the damages award and is appealing the judgment of the Court.
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DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Computer Sciences Corporation v. Eric Pulier, et al.: On May 12, 2015, CSC filed a civil complaint in the Court of Chancery of the State of Delaware against Eric Pulier, the former CEO of Service Mesh Inc. ("SMI"), which CSC had acquired in November 2013. The complaint asserted claims for fraud, breach of contract and breach of fiduciary duty, based on allegations that Mr. Pulier had engaged in fraudulent transactions with two employees of the Commonwealth Bank of Australia Ltd. (“CBA”). The Court dismissed CSC’s claim for breach of the implied covenant of good faith, but allowed substantially all of the remaining claims to proceed. Mr. Pulier asserted counter-claims for breach of contract, fraud, negligent representation, rescission, and violations of the California Blue Sky securities law, all of which the Court dismissed in whole or in part, except for claims for breach of Mr. Pulier’s retention agreement.
In July 2017, the Court granted a motion by the United States for a 90-day stay of discovery pending the completion of a criminal investigation by the U.S. Attorney’s Office for the Central District of California. In September 2017, a federal grand jury returned an indictment against Mr. Pulier, charging him with conspiracy, securities and wire fraud, obstruction of justice, and other violations of federal law (United States v. Eric Pulier, CR 17-599-AB). The Government sought an extension of the stay which the Delaware Chancery Court granted.
In December 2018, the Government filed an application to dismiss the indictment against Mr. Pulier, which was granted, and the indictment was dismissed with prejudice. In March 2019, the Delaware Chancery Court lifted the stay and denied CSC’s motion for a temporary restraining order and preliminary injunction with respect to certain of Mr. Pulier’s assets.
In August 2019, the Company entered into an agreement with Mr. Pulier, resolving all claims and counterclaims in the Delaware litigation through the division of amounts previously held in escrow for post-closing disputes.
The Securities and Exchange Commission (“SEC”) has filed a complaint against Mr. Pulier alleging various claims, including for fraud and falsifying books and records (Securities and Exchange Commission v. Eric Pulier, Case No. 2:17-cv-07124). The Court has set a trial date of December 1, 2020.
In February 2016, Mr. Pulier filed a complaint in Delaware Chancery Court seeking advancement of his legal fees and costs in the civil and criminal actions, pursuant to the terms of his agreements with SMI. The Court ruled that CSC Agility Platform - as the successor to SMI - is liable for advancing 80 % of Mr. Pulier’s fees and costs in the civil and criminal actions. Pursuant to agreements with SMI, Mr. Pulier is obligated to repay all amounts advanced to him if it should ultimately be determined that he is not entitled to indemnification.
The Company remains obligated to advance amounts for Mr. Pulier’s legal fees and costs to defend the SEC action against him.
Kemper Corporate Services, Inc. v. Computer Sciences Corporation: In October 2015, Kemper Corporate Services, Inc. (“Kemper”) filed a demand for arbitration against CSC with the American Arbitration Association (“AAA”), alleging that CSC breached the terms of a 2009 Master Software License and Services Agreement and related Work Orders (the “Agreement”) by failing to complete a software translation and implementation plan by certain contractual deadlines. Kemper claimed breach of contract, seeking approximately $100 million in damages. CSC answered the demand for arbitration denying Kemper’s claims and asserting a counterclaim for unpaid invoices for services rendered by CSC.
A single arbitrator conducted an evidentiary hearing on the merits of the claims and counterclaims in April 2017. In October 2017, the arbitrator issued a partial final award, finding for Kemper on its breach of contract theory, awarding Kemper $84.2 million in compensatory damages plus prejudgment interest, denying Kemper’s claim for rescission as moot, and denying CSC’s counterclaim. Kemper moved to confirm the award in federal district court in Texas.
CSC moved to vacate the award, and in August 2018, the Magistrate Judge issued its Report and Recommendation denying CSC's vacatur motion. In September 2018, the District Court summarily accepted the Report and Recommendation without further briefing and entered a Final Judgment in the case. The Company promptly filed a notice of appeal to the Fifth Circuit Court of Appeals. Following the submission of briefs, oral argument was held on September 5, 2019. On January 10, 2020, the Court of Appeals issued a decision denying the Company’s appeal. The Company has filed a Petition for Rehearing, seeking review by the entire en banc Court of Appeals. The Company expects a decision on its Petition in February 2020.
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DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
The Company has been pursuing coverage for the full scope of the award, interest, and legal fees and expenses, under the Company's applicable insurance policies. Certain carriers have accepted coverage while others have denied coverage. If the Company’s Petition for Rehearing is denied, the Company will pay the balance of the judgment not paid by its insurance carriers. This balance is estimated to be between $25 and $60 million. The Company believes it has coverage for these amounts and continues to discuss recovery with its insurance carriers. If necessary, the Company intends to vigorously pursue recovery from its insurance carriers.
Forsyth, et al. v. HP Inc. and Hewlett Packard Enterprise: On August 18, 2016, this purported class and collective action was filed in the U.S. District Court for the Northern District of California, against HP and HPE alleging violations of the Federal Age Discrimination in Employment Act (“ADEA”), the California Fair Employment and Housing Act, California public policy and the California Business and Professions Code. Former business units of HPE now owned by the Company may be proportionately liable for any recovery by plaintiffs in this matter.
Plaintiffs seek to certify a nationwide class action under the ADEA comprised of all U.S. residents employed by defendants who had their employment terminated pursuant to a work force reduction (“WFR”) plan and who were 40 years of age or older at the time of termination. The class seeks to cover those impacted by WFRs on or after December 2014. Plaintiffs also seek to represent a Rule 23 class under California law comprised of all persons 40 years of age or older employed by defendants in the state of California and terminated pursuant to a WFR plan on or after August 18, 2012.
In January 2017, defendants filed a partial motion to dismiss and a motion to compel arbitration of claims by certain named and opt-in plaintiffs who had signed release agreements as part of their WFR packages. In September 2017, the Court denied the partial motion to dismiss without prejudice, but granted defendants’ motions to compel arbitration for those named and opt-in plaintiffs. The Court has stayed the entire action pending arbitration for these individuals, and administratively closed the case.
A mediation was held in October 2018 with the 16 named and opt-in plaintiffs who were involved in the case at that time. A settlement was reached, which included seven plaintiffs who were employed by former business units of HPE that are now owned by the Company. In June 2019, a second mediation was held with 145 additional opt-in plaintiffs who were compelled to arbitration pursuant to their release agreements. In December 2019, a settlement was reached with 142 of the opt-in plaintiffs, 35 of whom were employed by former business units of HPE that are now owned by the Company, and for which the Company is liable.
Former business units of the Company now owned by Perspecta may be proportionately liable for any recovery by plaintiffs in this matter.
Oracle America, Inc., et al. v. Hewlett Packard Enterprise Company: On March 22, 2016, Oracle filed a complaint against HPE in the Northern District of California, alleging copyright infringement, interference with contract, intentional interference with prospective economic relations, and unfair competition. The litigation relates in part to former business units of HPE that are now owned by the Company. The Company may be required to indemnify HPE for a portion of any recovery by Oracle in the litigation related to these business units.
Oracle’s claims arise primarily out of HPE’s prior relationship with a third-party maintenance provider named Terix Computer Company, Inc. (“Terix”). Oracle claims that Terix infringed its copyrights while acting as HPE’s subcontractor for certain customers of HPE’s multivendor support business. Oracle claims that HPE is liable for vicarious and contributory infringement arising from the alleged actions of Terix and for direct infringement arising from its own alleged conduct.
On June 14, 2018, the court heard oral argument on the parties’ cross-motions for summary judgment. On January 29, 2019, the court granted HPE’s motion for summary judgment and denied Oracle’s motion for summary judgment, resolving the matter in HPE’s favor. Oracle has appealed the judgment to the U.S. Court of Appeals for the Ninth Circuit. The parties have submitted their initial briefs in the appellate case, and briefing is expected to conclude in November 2019. The parties have submitted their briefs in the appellate case and are awaiting the scheduling of oral argument.
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DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
In re DXC Technology Company Securities Litigation: On December 27, 2018, a purported class action lawsuit was filed in the United States District Court for the Eastern District of Virginia against the Company and two of its current officers. The lawsuit asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and is premised on allegedly false and/or misleading statements, and alleged non-disclosure of material facts, regarding the Company’s business, operations, prospects and performance during the proposed class period of February 8, 2018 to November 6, 2018. The Company has moved to dismiss the claims in their entirety. On July 26, 2019, the court heard oral argument on the Company’s motion to dismiss, and a decision is now pending.
In March 2019, three related shareholder derivative lawsuits were filed in the District Court of the State of Nevada, in and for Clark County, against two of the Company’s current officers and the members of the Company’s board of directors, asserting claims for breach of fiduciary duty, waste of corporate assets, and unjust enrichment. By agreement of the parties and order of the court, those lawsuits were consolidated on July 18, 2019, and are presently stayed pending resolution of the Company’s motion to dismiss in the federal putative class action filed in the Eastern District of Virginia.
On August 20, 2019, a purported class action lawsuit was filed in the Superior Court of the State of California, County of Santa Clara, against the Company and officers and directors of the Company, among other defendants. On September 16, 2019, a substantially similar purported class action lawsuit was filed in the United States District Court for the Northern District of California against the Company and officers and directors of the Company, among other defendants. On November 8, 2019, a third purported class action lawsuit was filed in the Superior Court of the State of California, County of San Mateo, against the Company and officers and directors of the Company, among other defendants. The third lawsuit was voluntarily dismissed by the plaintiff and re-filed in the Superior Court of the State of California, County of Santa Clara on November 26, 2019, and thereafter was consolidated with the earlier-filed action in the same court on December 10, 2019. The California lawsuits assert claims under Sections 11, 12 and 15 of the Securities Act of 1933, as amended, and are premised on allegedly false and/or misleading statements, and alleged non-disclosure of material facts, regarding the Company’s prospects and expected performance. Plaintiff in the federal action filed an amended complaint on January 8, 2020. The putative class of plaintiffs in these cases includes all persons who acquired shares of the Company’s common stock pursuant to the offering documents filed with the Securities and Exchange Commission in connection with the April 2017 transaction that formed DXC. The Company intends to file motions to stay the consolidated state court case in favor of the federal action and, ultimately, to dismiss all claims asserted in these actions.
On October 2, 2019, a shareholder derivative lawsuit was filed in the District Court of the State of Nevada, in and for Clark County, asserting various claims, including for breach of fiduciary duty and unjust enrichment, and challenging certain sales of securities by officers under Rule 10b5-1 plans. The shareholder filed this action after making a demand on the board of directors, alleging breaches of fiduciary duty, corporate waste and disclosure violations, and demanding that the board take certain actions to evaluate the allegations and respond. The Company’s board of directors analyzed the demand, and has determined to defer its decision on the demand pending developments in the securities and derivative lawsuits described above. The Company moved to dismiss the complaint on the basis that the Board’s decision to defer action was not a refusal of the demand and was within its discretion. The Company’s motion to dismiss was denied on January 22, 2020. The Company will seek to stay the matter pursuant to prior court orders staying related derivative lawsuits pending before the court.
The Company believes that the lawsuits described above are without merit, and it intends to vigorously defend them.
Voluntary Disclosure of Certain Possible Sanctions Law Violations: On February 2, 2017, CSC submitted an initial notification of voluntary disclosure to the U.S. Department of Treasury, Office of Foreign Assets Control ("OFAC") regarding certain possible violations of U.S. sanctions laws pertaining to insurance premium data and claims data processed by two partially-owned joint ventures of Xchanging, which CSC acquired during the first quarter of fiscal 2017. A copy of the disclosure was also provided to Her Majesty’s Treasury Office of Financial Sanctions Implementation in the United Kingdom. The Company is finalizing its internal investigation and provided supplemental information to OFAC on January 31, 2020.
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DXC TECHNOLOGY COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) - continued
Perspecta Arbitration: In October 2019, Perspecta Inc. (“Perspecta”) submitted a demand for arbitration claiming that in June 2018 DXC breached certain obligations under the Separation and Distribution Agreement between Perspecta and DXC, and seeking at least $120 million in alleged damages. In December 2019, Perspecta increased its claim to $500 million, without specifying the basis for its damages. In its arbitration demand, Perspecta also challenges $39 million in invoices issued by DXC in June 2019 under its IT Services Agreement with Perspecta. DXC believes the invoices were properly issued and the amounts are owed by Perspecta. DXC believes that Perspecta's claims are without merit and intends to vigorously defend itself.
In addition to the matters noted above, the Company is currently subject in the normal course of business to various claims and contingencies arising from, among other things, disputes with customers, vendors, employees, contract counterparties and other parties, as well as securities matters, environmental matters, matters concerning the licensing and use of intellectual property, and inquiries and investigations by regulatory authorities and government agencies. Some of these disputes involve or may involve litigation. The financial statements reflect the treatment of claims and contingencies based on management's view of the expected outcome. DXC consults with outside legal counsel on issues related to litigation and regulatory compliance and seeks input from other experts and advisors with respect to matters in the ordinary course of business. Although the outcome of these and other matters cannot be predicted with certainty, and the impact of the final resolution of these and other matters on the Company’s results of operations in a particular subsequent reporting period could be material and adverse, management does not believe based on information currently available to the Company, that the resolution of any of the matters currently pending against the Company will have a material adverse effect on the financial position of the Company or the ability of the Company to meet its financial obligations as they become due. Unless otherwise noted, the Company is unable to determine at this time a reasonable estimate of a possible loss or range of losses associated with the foregoing disclosed contingent matters.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
All statements and assumptions contained in this Quarterly Report on Form 10-Q and in the documents incorporated by reference that do not directly and exclusively relate to historical facts constitute “forward-looking statements.” Forward-looking statements often include words such as “anticipates,” “believes,” “estimates,” “expects,” “forecast,” “goal,” “intends,” “objective,” “plans,” “projects,” “strategy,” “target,” and “will” and words and terms of similar substance in discussions of future operating or financial performance. These statements represent current expectations and beliefs, and no assurance can be given that the results described in such statements will be achieved.
Forward-looking statements include, among other things, statements with respect to our financial condition, results of operations, cash flows, business strategies, operating efficiencies or synergies, divestitures, competitive position, growth opportunities, share repurchases, dividend payments, plans and objectives of management and other matters. Such statements are subject to numerous assumptions, risks, uncertainties and other factors that could cause actual results to differ materially from those described in such statements, many of which are outside of our control. Important factors that could cause actual results to differ materially from those described in forward-looking statements include, but are not limited to:
• | the integration of Computer Sciences Corporation's ("CSC") and Enterprise Services business of Hewlett Packard Enterprise Company's ("HPES") businesses, operations, and culture and the ability to operate as effectively and efficiently as expected, and the combined company's ability to successfully manage and integrate acquisitions generally; |
• | the ability to realize the synergies and benefits expected to result from the HPES Merger within the anticipated time frame or in the anticipated amounts; |
• | other risks related to the HPES Merger including anticipated tax treatment, unforeseen liabilities, and future capital expenditures; |
• | risks relating to the Luxoft Acquisition and the ability to achieve the expected results therefrom; |
• | the U.S. Public Sector business ("USPS") Separation and Mergers as described in Note 1 - “Summary of Significant Accounting Policies”, could result in substantial tax liability to DXC and our stockholders; |
• | changes in governmental regulations or the adoption of new laws or regulations that may make it more difficult or expensive to operate our business; |
• | changes in senior management, the loss of key employees or the ability to retain and hire key personnel and maintain relationships with key business partners; |
• | the risk of liability or damage to our reputation resulting from security breaches or disclosure of sensitive data or failure to comply with data protection laws and regulations; |
• | business interruptions in connection with our technology systems; |
• | the competitive pressures faced by our business; |
• | the effects of macroeconomic and geopolitical trends and events; |
• | the need to manage third-party suppliers and the effective distribution and delivery of our products and services; |
• | the protection of our intellectual property assets, including intellectual property licensed from third parties; |
• | the risks associated with international operations; |
• | the development and transition of new products and services and the enhancement of existing products and services to meet customer needs, respond to emerging technological trends and maintain and grow our customer relationships over time; |
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• | the ability to succeed in our strategic objectives, including strategic alternatives material for our business; |
• | the execution and performance of contracts by us and our suppliers, customers, clients and partners; |
• | our credit rating and the ability to manage working capital, refinance and raise additional capital for future needs; |
• | our ability to remediate any material weakness and maintain effective internal control over financial reporting; |
• | the resolution of pending investigations, claims and disputes; and |
• | the other factors described in Part I Item 1A "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended March 31, 2019 and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarterly periods ended June 30, 2019 and September 30, 2019 and of this Quarterly Report on Form 10-Q. |
No assurance can be given that any goal or plan set forth in any forward-looking statement can or will be achieved, and readers are cautioned not to place undue reliance on such statements which speak only as of the date they are made. We do 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 of this Quarterly Report on Form 10-Q or to reflect the occurrence of unanticipated events, except as required by law.
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ITEM 2. 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 third quarter and the first nine months of fiscal 2020 and our financial condition as of December 31, 2019. The MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and accompanying 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 the third quarters and the first nine months of fiscal 2020 and fiscal 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 clients through our direct sales force operating out of sales offices around the world. Our clients include commercial businesses of many sizes and in many industries and public sector enterprises.
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Results of Operations
The following table sets forth certain financial data for the third quarters and first nine months of fiscal 2020 and fiscal 2019:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In millions, except per-share amounts) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||
Revenues | $ | 5,021 | $ | 5,178 | $ | 14,762 | $ | 15,473 | ||||||||
Income (loss) from continuing operations, before taxes | 127 | 469 | (1,666 | ) | 1,161 | |||||||||||
Income tax expense | 37 | 3 | 191 | 205 | ||||||||||||
Income (loss) from continuing operations | 90 | 466 | (1,857 | ) | 956 | |||||||||||
Income from discontinued operations, net of taxes | — | — | — | 35 | ||||||||||||
Net income (loss) | $ | 90 | $ | 466 | $ | (1,857 | ) | $ | 991 | |||||||
Diluted earnings (loss) per share: | ||||||||||||||||
Continuing operations | $ | 0.32 | $ | 1.66 | $ | (7.20 | ) | $ | 3.33 | |||||||
Discontinued operations | $ | — | $ | — | $ | — | $ | 0.12 | ||||||||
Fiscal 2020 Highlights
Financial highlights for the third quarter and first nine months of fiscal 2020 include the following:
• | Revenues for the third quarter and first nine months of fiscal 2020 were $5.0 billion and $14.8 billion, respectively, a decrease of 3% and 5%, respectively, as compared to the same periods of the prior fiscal year. |
• | Income from continuing operations and diluted EPS from continuing operations for the third quarter of fiscal 2020 were $90 million and $0.32, respectively, including the cumulative impact of certain items of $(238) million, reflecting restructuring costs, transaction, separation and integration-related costs, amortization of acquired intangible assets and a tax adjustment related to U.S. tax reform. This compares with income from continuing operations and diluted EPS from continuing operations of $466 million and $1.66, respectively, for the same period of the prior fiscal year. |
• | Loss from continuing operations and diluted EPS from continuing operations for the first nine months of fiscal 2020 were $1,857 million and $7.20, respectively, including the cumulative impact of certain items of $(3,019) million, reflecting restructuring costs, transaction, separation and integration-related costs, amortization of acquired intangible assets, goodwill impairment losses, gain on arbitration award and a tax adjustment related to U.S. tax reform. This compares with income from continuing operations and diluted EPS from continuing operations of $956 million and $3.33, respectively, for the same period of the prior fiscal year. |
• | Our cash and cash equivalents were $2.6 billion as of December 31, 2019. |
• | We generated $2,062 million of cash from operations during the first nine months of fiscal 2020, as compared to cash generated of $1,035 million during the first nine months of fiscal 2019. |
• | We returned $897 million to shareholders in the form of common stock dividends and share repurchases during the first nine months of fiscal 2020, as compared to $1,407 million during the first nine months of fiscal 2019. |
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Revenues
Three Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | Change | Percentage Change | |||||||||||
GBS | $ | 2,359 | $ | 2,169 | $ | 190 | 8.8 | % | |||||||
GIS | 2,662 | 3,009 | (347 | ) | (11.5 | )% | |||||||||
Total Revenues | $ | 5,021 | $ | 5,178 | $ | (157 | ) | (3.0 | )% | ||||||
Nine Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | Change | Percentage Change | |||||||||||
GBS | $ | 6,803 | $ | 6,493 | $ | 310 | 4.8 | % | |||||||
GIS | 7,959 | 8,980 | (1,021 | ) | (11.4 | )% | |||||||||
Total Revenues | $ | 14,762 | $ | 15,473 | $ | (711 | ) | (4.6 | )% | ||||||
The decrease in revenues for the first nine months of fiscal 2020, compared with fiscal 2019 of the same period, reflects an ongoing decline in our traditional application maintenance business and legacy infrastructure services. 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 Euro and British Pound.
During the third quarter and first nine months of fiscal 2020 and fiscal 2019, the distribution of our revenues across geographies was as follows:
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For the discussion of risks associated with our foreign operations, see Part 1, Item 1A "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended March 31, 2019.
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As a global company, approximately 63% of our revenues for the first nine months of fiscal 2020 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 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:
Three Months Ended | |||||||||||||||
(in millions) | Constant Currency December 31, 2019 | December 31, 2018 | Change | Percentage Change | |||||||||||
GBS | $ | 2,384 | $ | 2,169 | $ | 215 | 9.9 | % | |||||||
GIS | 2,691 | 3,009 | (318 | ) | (10.6 | )% | |||||||||
Total | $ | 5,075 | $ | 5,178 | $ | (103 | ) | (2.0 | )% | ||||||
Nine Months Ended | |||||||||||||||
(in millions) | Constant Currency December 31, 2019 | December 31, 2018 | Change | Percentage Change | |||||||||||
GBS | $ | 6,942 | $ | 6,493 | $ | 449 | 6.9 | % | |||||||
GIS | 8,165 | 8,980 | (815 | ) | (9.1 | )% | |||||||||
Total | $ | 15,107 | $ | 15,473 | $ | (366 | ) | (2.4 | )% | ||||||
Global Business Services
GBS revenue was $2,359 million in the third quarter and $6,803 million in the first nine months of fiscal 2020, an increase of 8.8% and 4.8%, respectively, compared to the corresponding periods in fiscal 2019. GBS revenue in constant currency increased 9.9% and 6.9% in the third quarter and first nine months of fiscal 2020, respectively, as compared to the corresponding periods in fiscal 2019. The increase in GBS revenue in fiscal 2020 periods reflects the contributions from our Luxoft and other acquisitions further discussed in Note 3 - "Acquisitions".
For the third quarter and first nine months of fiscal 2020, GBS contract awards were $2.5 billion and $6.8 billion, respectively, as compared to $2.3 billion and $6.5 billion in the corresponding periods of fiscal 2019.
Global Infrastructure Services
GIS revenue was $2,662 million in the third quarter and $7,959 million in the first nine months of fiscal 2020, a decrease of 11.5% and 11.4%, respectively, compared to the corresponding periods in fiscal 2019. GIS revenue in constant currency decreased 10.6% and 9.1% in the third quarter and first nine months of fiscal 2020, respectively, as compared to the corresponding periods in fiscal 2019. The decrease in GIS revenues in fiscal 2020 periods reflects declines in our traditional infrastructure businesses.
For the third quarter and first nine months of fiscal 2020, GIS contract awards were $2.8 billion and $6.5 billion, respectively, as compared to $3.4 billion and $8.5 billion in the corresponding periods of fiscal 2019.
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Costs and Expenses
Our total costs and expenses are shown in the tables below:
Three Months Ended | |||||||||||||||||
Amount | Percentage of Revenues | Percentage Point Change | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | |||||||||||||
Costs of services (excludes depreciation and amortization and restructuring costs) | $ | 3,827 | $ | 3,725 | 76.1 | % | 71.8 | % | 4.3 | ||||||||
Selling, general, and administrative (excludes depreciation and amortization and restructuring costs) | 518 | 491 | 10.3 | 9.5 | 0.8 | ||||||||||||
Depreciation and amortization | 479 | 508 | 9.5 | 9.8 | (0.3 | ) | |||||||||||
Goodwill impairment losses | 53 | — | 1.1 | — | 1.1 | ||||||||||||
Restructuring costs | 74 | 76 | 1.5 | 1.5 | — | ||||||||||||
Interest expense | 93 | 81 | 1.9 | 1.6 | 0.3 | ||||||||||||
Interest income | (33 | ) | (27 | ) | (0.7 | ) | (0.5 | ) | (0.2 | ) | |||||||
Other income, net | (117 | ) | (145 | ) | (2.3 | ) | (2.8 | ) | 0.5 | ||||||||
Total costs and expenses | $ | 4,894 | $ | 4,709 | 97.5 | % | 90.9 | % | 6.6 | ||||||||
Nine Months Ended | |||||||||||||||||
Amount | Percentage of Revenues | Percentage Point Change | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | |||||||||||||
Costs of services (excludes depreciation and amortization and restructuring costs) | $ | 11,128 | $ | 11,110 | 75.3 | % | 71.8 | % | 3.5 | ||||||||
Selling, general, and administrative (excludes depreciation and amortization and restructuring costs) | 1,514 | 1,500 | 10.3 | 9.7 | 0.6 | ||||||||||||
Depreciation and amortization | 1,416 | 1,463 | 9.6 | 9.5 | 0.1 | ||||||||||||
Goodwill impairment losses | 2,940 | — | 19.9 | — | 19.9 | ||||||||||||
Restructuring costs | 248 | 418 | 1.7 | 2.7 | (1.0 | ) | |||||||||||
Interest expense | 288 | 249 | 2.0 | 1.6 | 0.4 | ||||||||||||
Interest income | (130 | ) | (92 | ) | (0.9 | ) | (0.6 | ) | (0.3 | ) | |||||||
Gain on arbitration award | (632 | ) | — | (4.3 | ) | — | (4.3 | ) | |||||||||
Other income, net | (344 | ) | (336 | ) | (2.3 | ) | (2.2 | ) | (0.1 | ) | |||||||
Total costs and expenses | $ | 16,428 | $ | 14,312 | 111.3 | % | 92.5 | % | 18.8 | ||||||||
The 6.6 point increase in costs and expenses as a percentage of revenue for the third quarter primarily reflects the cumulative impact of increases in selling, general and administrative costs and amortization costs. In addition, the third quarter includes an adjustment that increased costs related to goodwill impairment losses. The 18.8 point increase in costs and expenses as a percentage of revenue for the first nine months of fiscal 2020 primarily reflects our goodwill impairment losses, which were partially offset by the gain on arbitration award.
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Costs of Services
Cost of services, excluding depreciation and amortization and restructuring costs ("COS"), was $3.8 billion and $11.1 billion for the third quarter and first nine months of fiscal 2020, respectively. COS increased $102 million during the third quarter of fiscal 2020 and increased $18 million during the first nine months of fiscal 2020, as compared to the same periods of the prior fiscal year.
COS as a percentage of revenue increased 4.3 points and 3.5 points for the third quarter and first nine months of fiscal 2020, respectively. These increases were driven by the decline in revenue exceeding associated cost reductions in our traditional infrastructure businesses.
Selling, General, and Administrative
Selling, general, and administrative expense, excluding depreciation and amortization and restructuring costs ("SG&A"), was $518 million and $1,514 million for the third quarter and first nine months of fiscal 2020, respectively. SG&A increased $27 million and $14 million during the third quarter and first nine months of fiscal 2020, respectively, as compared to the same periods of the prior fiscal year. These increases included SG&A related to the Luxoft Acquisition, which we acquired during the first quarter of fiscal 2020.
Transaction, separation and integration-related costs of $68 million and $226 million were included in SG&A for the third quarter and first nine months of fiscal 2020, respectively, as compared to $107 million and $305 million for the comparable periods of the prior fiscal year.
Depreciation and Amortization
Depreciation expense decreased $88 million and amortization expense increased $59 million for the three months ended December 31, 2019, compared to the three months ended December 31, 2018. For the first nine months of fiscal 2020, depreciation expense decreased $138 million and amortization expense increased $91 million compared to the first nine months of fiscal 2019.
The net decrease in depreciation for the third quarter and first nine months of fiscal 2020 was primarily due to a $68 million and $179 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 dissipation of the benefit from the conversion of assets from operating to finance leases.
The increases in amortization expense for the third quarter and first nine months of fiscal 2020 were primarily due to increases in software amortization and amortization related to accelerated transition and transformation contract costs.
Goodwill Impairment Losses
DXC recognized goodwill impairment charges totaling $53 million and $2,940 million for the third quarter and the first nine months of fiscal 2020. The impairment charge was primarily as a result of a decline in market capitalization during the fiscal 2020 second quarter. The impairment charge was adjusted during the third quarter of fiscal 2020 due to an out-of-period correction that also affected income tax benefit. See Note 11, "Goodwill" for additional information.
Restructuring Costs
During fiscal 2020, management approved global cost savings initiatives designed to reduce operating costs by re-balancing our workforce and facilities structures. During the third quarter and first nine months of fiscal 2020, restructuring costs, net of reversals, were $74 million and $248 million, respectively, as compared to $76 million and $418 million during the same periods of the prior fiscal year. Restructuring costs for the first nine months of fiscal 2020 included $23 million of reversals under the Fiscal 2020 Plan.
For an analysis of changes in our restructuring liabilities by restructuring plan, see Note 14 - "Restructuring Costs" to the financial statements.
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Interest Expense and Interest Income
Interest expense for the third quarter and first nine months of fiscal 2020 increased $12 million and $39 million, respectively, over the same periods in the prior fiscal year. The increase in interest expense in the third quarter and first nine months of fiscal 2020, versus the same periods in fiscal 2019, was primarily due to an increase in borrowings and asset financing activities. See the "Capital Resources" caption below and Note 12 - “Debt” for additional information.
Interest income for the third quarter and first nine months of fiscal 2020 increased $6 million and $38 million, respectively over the same periods in the prior fiscal year. The year-over-year increase in interest income during the third quarter of fiscal 2020 was due to an increase in income from cash pool arrangements and deposits. The increase in interest income in the first nine months of fiscal 2020, versus the same periods in fiscal 2019, 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 comprises 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 and other miscellaneous gains and losses.
The $28 million decrease in other income, net for the third quarter of fiscal 2020, as compared to the same period of the prior fiscal year, was due to a year-over-year decrease of $62 million in other gains related to sales of non-operating assets. This decrease was offset by a $19 million increase in non-service components of net periodic pension income and a year-over-year favorable foreign currency impact of $15 million.
The $8 million increase in other income, net for the first nine months of fiscal 2020, as compared to the same period of the prior fiscal year, was due to a year-over-year increase of $61 million in non-service components of net periodic pension income and a year-over-year favorable foreign currency impact of $57 million. These increases were offset by a $110 million decrease in other gains related to sales of non-operating assets.
Taxes
Our ETR from continuing operations was 29.1% and 0.6% for the three months ended December 31, 2019 and December 31, 2018, respectively, and (11.5)% and 17.7% for the nine months ended December 31, 2019 and December 31, 2018, respectively. For the three months ended December 31, 2019, the primary drivers of the ETR were the impact of previously unrecognized tax effects on the tax deductible goodwill impaired during the fiscal 2020 second quarter, the global mix of income, an increase in prior year U.S. federal research and development income tax credits, and an increase in unrecognized tax benefits primarily related to audit activity. For the nine months ended December 31, 2019, the primary drivers of the ETR were the impact of the non-deductible goodwill impairment charge, the non-taxable gain on the arbitration award, the global mix of income, an increase in unrecognized tax benefits primarily related to audit activity, and an increase in prior year U.S. federal research and development income tax credits, net. For the three and nine months ended December 31, 2018, the primary drivers of the ETR were the global mix of income, the impact of U.S. proposed regulations on the ability to claim certain foreign tax credits, the filing of the October 31, 2017 U.S. federal tax return, the decrease to the provisional transition tax and a decrease in valuation allowances on certain foreign subsidiary deferred tax assets.
Income from Discontinued Operations
The $35 million of income from discontinued operations for the first nine months of fiscal 2019 reflects the net income generated by USPS during the first quarter of fiscal 2019.
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Earnings (Loss) Per Share
Diluted EPS from continuing operations for the third quarter and first nine months of fiscal 2020 decreased $1.34 and $10.53, respectively, from the same periods in the prior fiscal year. This decrease reflects a decrease of $376 million and $2,813 million in income from continuing operations for the third quarter and first nine months of fiscal 2020, respectively, over the same periods in the prior fiscal year.
Diluted EPS from continuing operations for the third quarter of fiscal 2020 includes $0.25 per share of restructuring costs, $0.20 per share of transaction, separation and integration-related costs, $0.44 per share of amortization of acquired intangible assets, and $0.04 per share of tax adjustment related to prior restructuring charges.
Diluted EPS from continuing operations for the first nine months of fiscal 2020 includes $0.79 per share of restructuring costs, $0.70 per share of transaction, separation and integration-related costs, $1.28 per share of amortization of acquired intangible assets, $11.03 per share of goodwill impairment losses, $(2.42) per share of arbitration award gains, and $0.15 per share of tax adjustment relating to prior restructuring charges.
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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.
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Non-GAAP financial measures and the respective most directly comparable financial measures calculated and presented in accordance with GAAP include:
Three Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | Change | Percentage Change | |||||||||||
Income from continuing operations before income taxes | $ | 127 | $ | 469 | $ | (342 | ) | (72.9 | )% | ||||||
Non-GAAP income from continuing operations before income taxes | $ | 468 | $ | 786 | $ | (318 | ) | (40.5 | )% | ||||||
Net income | $ | 90 | $ | 466 | $ | (376 | ) | (80.7 | )% | ||||||
Adjusted EBIT | $ | 528 | $ | 840 | $ | (312 | ) | (37.1 | )% | ||||||
Nine Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | Change | Percentage Change | |||||||||||
(Loss) income from continuing operations before income taxes | $ | (1,666 | ) | $ | 1,161 | $ | (2,827 | ) | (243.5 | )% | |||||
Non-GAAP income from continuing operations before income taxes | $ | 1,551 | $ | 2,285 | $ | (734 | ) | (32.1 | )% | ||||||
Net (loss) income | $ | (1,857 | ) | $ | 991 | $ | (2,848 | ) | (287.4 | )% | |||||
Adjusted EBIT | $ | 1,709 | $ | 2,442 | $ | (733 | ) | (30.0 | )% | ||||||
Reconciliation of Non-GAAP Financial Measures
Our non-GAAP adjustments include:
• | Restructuring costs - reflects costs, net of reversals, related to workforce optimization and real estate charges. |
• | 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. |
• | 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. |
• | Tax adjustment - for fiscal 2020 periods include the impact of Transition Tax (affecting the three and nine months ended December 31, 2019) and tax entries related to prior restructuring charges (affecting the nine months ended December 31, 2019). Fiscal 2019 periods reflect the estimated non-recurring benefit of the Tax Cuts and Jobs Act of 2017. 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. |
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A reconciliation of reported results to non-GAAP results is as follows:
Three Months Ended December 31, 2019 | ||||||||||||||||||||||||||||
(in millions, except per-share amounts) | As Reported | Restructuring Costs | Transaction, Separation and Integration-Related Costs | Amortization of Acquired Intangible Assets | Goodwill Impairment Losses | Tax Adjustment | Non-GAAP Results | |||||||||||||||||||||
Costs of services (excludes depreciation and amortization and restructuring costs) | $ | 3,827 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 3,827 | ||||||||||||||
Selling, general, and administrative (excludes depreciation and amortization and restructuring costs) | 518 | — | (68 | ) | — | — | — | 450 | ||||||||||||||||||||
Income from continuing operations before income taxes | 127 | 74 | 68 | 146 | 53 | — | 468 | |||||||||||||||||||||
Income tax expense | 37 | 10 | 16 | 34 | 53 | (10 | ) | 140 | ||||||||||||||||||||
Net income | 90 | 64 | 52 | 112 | — | 10 | 328 | |||||||||||||||||||||
Less: net income attributable to non-controlling interest, net of tax | 8 | — | — | — | — | — | 8 | |||||||||||||||||||||
Net income attributable to DXC common stockholders | $ | 82 | $ | 64 | $ | 52 | $ | 112 | $ | — | $ | 10 | $ | 320 | ||||||||||||||
Effective Tax Rate | 29.1 | % | 29.9 | % | ||||||||||||||||||||||||
Basic EPS from continuing operations | $ | 0.32 | $ | 0.25 | $ | 0.20 | $ | 0.44 | $ | — | $ | 0.04 | $ | 1.25 | ||||||||||||||
Diluted EPS from continuing operations | $ | 0.32 | $ | 0.25 | $ | 0.20 | $ | 0.44 | $ | — | $ | 0.04 | $ | 1.25 | ||||||||||||||
Weighted average common shares outstanding for: | ||||||||||||||||||||||||||||
Basic EPS | 255.09 | 255.09 | 255.09 | 255.09 | 255.09 | 255.09 | 255.09 | |||||||||||||||||||||
Diluted EPS | 256.05 | 256.05 | 256.05 | 256.05 | 256.05 | 256.05 | 256.05 | |||||||||||||||||||||
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Nine Months Ended December 31, 2019 | ||||||||||||||||||||||||||||||||
(in millions, except per-share amounts) | As Reported | Restructuring Costs | Transaction, Separation and Integration-Related Costs | Amortization of Acquired Intangible Assets | Goodwill Impairment Losses | Gain on Arbitration Award | Tax Adjustment | Non-GAAP Results | ||||||||||||||||||||||||
Costs of services (excludes depreciation and amortization and restructuring costs) | $ | 11,128 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 11,128 | ||||||||||||||||
Selling, general, and administrative (excludes depreciation and amortization and restructuring costs) | 1,514 | — | (226 | ) | — | — | — | — | 1,288 | |||||||||||||||||||||||
(Loss) income from continuing operations before income taxes | (1,666 | ) | 248 | 226 | 435 | 2,940 | (632 | ) | — | 1,551 | ||||||||||||||||||||||
Income tax expense | 191 | 42 | 43 | 99 | 53 | — | (39 | ) | 389 | |||||||||||||||||||||||
Net (loss) income | (1,857 | ) | 206 | 183 | 336 | 2,887 | (632 | ) | 39 | 1,162 | ||||||||||||||||||||||
Less: net income attributable to non-controlling interest, net of tax | 17 | — | — | — | — | — | — | 17 | ||||||||||||||||||||||||
Net (loss) income attributable to DXC common stockholders | $ | (1,874 | ) | $ | 206 | $ | 183 | $ | 336 | $ | 2,887 | $ | (632 | ) | $ | 39 | $ | 1,145 | ||||||||||||||
Effective Tax Rate | (11.5 | )% | 25.1 | % | ||||||||||||||||||||||||||||
Basic EPS from continuing operations | $ | (7.20 | ) | $ | 0.79 | $ | 0.70 | $ | 1.29 | $ | 11.09 | $ | (2.43 | ) | $ | 0.15 | $ | 4.40 | ||||||||||||||
Diluted EPS from continuing operations | $ | (7.20 | ) | $ | 0.79 | $ | 0.70 | $ | 1.28 | $ | 11.03 | $ | (2.42 | ) | $ | 0.15 | $ | 4.38 | ||||||||||||||
Weighted average common shares outstanding for: | ||||||||||||||||||||||||||||||||
Basic EPS | 260.24 | 260.24 | 260.24 | 260.24 | 260.24 | 260.24 | 260.24 | 260.24 | ||||||||||||||||||||||||
Diluted EPS | 260.24 | 261.69 | 261.69 | 261.69 | 261.69 | 261.69 | 261.69 | 261.69 | ||||||||||||||||||||||||
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Three Months Ended December 31, 2018 | ||||||||||||||||||||||||
(in millions, except per-share amounts) | As Reported | Restructuring Costs | Transaction, Separation and Integration-Related Costs | Amortization of Acquired Intangible Assets | Tax Adjustment | Non-GAAP Results | ||||||||||||||||||
Costs of services (excludes depreciation and amortization and restructuring costs) | $ | 3,725 | $ | — | $ | — | $ | — | $ | — | $ | 3,725 | ||||||||||||
Selling, general, and administrative (excludes depreciation and amortization and restructuring costs) | 491 | — | (107 | ) | — | — | $ | 384 | ||||||||||||||||
Income from continuing operations before income taxes | 469 | 76 | 107 | 134 | — | 786 | ||||||||||||||||||
Income tax expense | 3 | 18 | 26 | 36 | 77 | 160 | ||||||||||||||||||
Income from continuing operations | 466 | 58 | 81 | 98 | (77 | ) | 626 | |||||||||||||||||
Income from discontinued operations, net of tax | — | — | — | — | — | — | ||||||||||||||||||
Net income | 466 | 58 | 81 | 98 | (77 | ) | 626 | |||||||||||||||||
Less: net income attributable to non-controlling interest, net of tax | 4 | — | — | — | — | 4 | ||||||||||||||||||
Net income attributable to DXC common stockholders | $ | 462 | $ | 58 | $ | 81 | $ | 98 | $ | (77 | ) | $ | 622 | |||||||||||
Effective Tax Rate | 0.6 | % | 20.4 | % | ||||||||||||||||||||
Basic EPS from continuing operations | $ | 1.68 | $ | 0.21 | $ | 0.29 | $ | 0.36 | $ | (0.28 | ) | $ | 2.26 | |||||||||||
Diluted EPS from continuing operations | $ | 1.66 | $ | 0.21 | $ | 0.29 | $ | 0.35 | $ | (0.28 | ) | $ | 2.23 | |||||||||||
Weighted average common shares outstanding for: | ||||||||||||||||||||||||
Basic EPS | 275.66 | 275.66 | 275.66 | 275.66 | 275.66 | 275.66 | ||||||||||||||||||
Diluted EPS | 278.99 | 278.99 | 278.99 | 278.99 | 278.99 | 278.99 | ||||||||||||||||||
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Nine Months Ended December 31, 2018 | ||||||||||||||||||||||||
(in millions, except per-share amounts) | As Reported | Restructuring Costs | Transaction, Separation and Integration-Related Costs | Amortization of Acquired Intangible Assets | Tax Adjustment | Non-GAAP Results | ||||||||||||||||||
Costs of services (excludes depreciation and amortization and restructuring costs) | $ | 11,110 | $ | — | $ | — | $ | — | $ | — | $ | 11,110 | ||||||||||||
Selling, general, and administrative (excludes depreciation and amortization and restructuring costs) | 1,500 | — | (305 | ) | — | — | $ | 1,195 | ||||||||||||||||
Income from continuing operations before income taxes | 1,161 | 418 | 305 | 401 | — | 2,285 | ||||||||||||||||||
Income tax expense | 205 | 100 | 72 | 101 | 44 | 522 | ||||||||||||||||||
Income from continuing operations | 956 | 318 | 233 | 300 | (44 | ) | 1,763 | |||||||||||||||||
Income from discontinued operations, net of tax | 35 | — | — | — | — | 35 | ||||||||||||||||||
Net income | 991 | 318 | 233 | 300 | (44 | ) | 1,798 | |||||||||||||||||
Less: net income attributable to non-controlling interest, net of tax | 8 | — | — | — | — | 8 | ||||||||||||||||||
Net income attributable to DXC common stockholders | $ | 983 | $ | 318 | $ | 233 | $ | 300 | $ | (44 | ) | $ | 1,790 | |||||||||||
Effective Tax Rate | 17.7 | % | 22.8 | % | ||||||||||||||||||||
Basic EPS from continuing operations | $ | 3.38 | $ | 1.13 | $ | 0.83 | $ | 1.07 | $ | (0.16 | ) | $ | 6.26 | |||||||||||
Diluted EPS from continuing operations | $ | 3.33 | $ | 1.12 | $ | 0.82 | $ | 1.05 | $ | (0.15 | ) | $ | 6.16 | |||||||||||
Weighted average common shares outstanding for: | ||||||||||||||||||||||||
Basic EPS | 280.47 | 280.47 | 280.47 | 280.47 | 280.47 | 280.47 | ||||||||||||||||||
Diluted EPS | 284.70 | 284.70 | 284.70 | 284.70 | 284.70 | 284.70 | ||||||||||||||||||
A reconciliation of net income to adjusted EBIT is as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | ||||||||||||
Net income (loss) | $ | 90 | $ | 466 | $ | (1,857 | ) | $ | 991 | |||||||
Income from discontinued operations, net of taxes | — | — | — | (35 | ) | |||||||||||
Income tax expense | 37 | 3 | 191 | 205 | ||||||||||||
Interest income | (33 | ) | (27 | ) | (130 | ) | (92 | ) | ||||||||
Interest expense | 93 | 81 | 288 | 249 | ||||||||||||
EBIT | 187 | 523 | (1,508 | ) | 1,318 | |||||||||||
Restructuring costs | 74 | 76 | 248 | 418 | ||||||||||||
Transaction, separation and integration-related costs | 68 | 107 | 226 | 305 | ||||||||||||
Amortization of acquired intangible assets | 146 | 134 | 435 | 401 | ||||||||||||
Goodwill impairment losses | 53 | — | 2,940 | — | ||||||||||||
Gain on arbitration award | — | — | (632 | ) | — | |||||||||||
Adjusted EBIT | $ | 528 | $ | 840 | $ | 1,709 | $ | 2,442 | ||||||||
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Liquidity and Capital Resources
Cash and Cash Equivalents and Cash Flows
As of December 31, 2019, our cash and cash equivalents were $2.6 billion, of which $1.5 billion was held outside of the U.S. A substantial portion of funds can be returned to the U.S. from funds advanced previously to finance our foreign acquisition initiatives. As a result of the Tax Cuts and Jobs Act of 2017, and after the mandatory one-time income inclusion (deemed repatriation) of the historically untaxed earnings of our foreign subsidiaries, we expect a significant portion of the cash and cash equivalents held by our foreign subsidiaries will no longer be subject to U.S. income tax consequences upon subsequent repatriation to the United States. However, a portion of this cash may still be subject to foreign income tax consequences upon future remittance. Therefore, if additional funds held outside the U.S. are needed for our operations in the U.S., we plan to repatriate these funds.
Cash and cash equivalents ("cash") were $2.9 billion and $2.6 billion for March 31, 2019 and December 31, 2019, respectively. The following table summarizes our cash flow activity:
Nine Months Ended | ||||||||||||
(in millions) | December 31, 2019 | December 31, 2018 | Change | |||||||||
Net cash provided by operating activities | $ | 2,062 | $ | 1,035 | $ | 1,027 | ||||||
Net cash used in investing activities | (2,122 | ) | (40 | ) | (2,082 | ) | ||||||
Net cash used in financing activities | (305 | ) | (1,183 | ) | 878 | |||||||
Effect of exchange rate changes on cash and cash equivalents | 26 | (66 | ) | 92 | ||||||||
Net decrease in cash and cash equivalents | $ | (339 | ) | $ | (254 | ) | $ | (85 | ) | |||
Cash and cash equivalents at beginning-of-year | 2,899 | 2,729 | ||||||||||
Cash and cash equivalents at the end-of-period | $ | 2,560 | $ | 2,475 | ||||||||
Net cash provided by operating activities during the first nine months of fiscal 2020 was $2,062 million as compared to $1,035 million during the comparable period of the prior fiscal year. The year-over-year increase of $1,027 million was due to an increase in net income, net of adjustments of $730 million, which includes cash received on arbitration award of $668 million and a decrease in working capital cash outflows of $297 million.
Net cash used in investing activities during the first nine months of fiscal 2020 was $2,122 million as compared to $40 million during the comparable period of the prior fiscal year. The increase of $2,082 million was predominately due to an increase in cash paid for acquisitions of $1,665 million, a decrease in cash collections related to deferred purchase price receivable of $248 million, a decrease in proceeds from sale of assets of $228 million, and short-term investing of $75 million. The increase is partially offset by a decrease in payments for transition and transformation contract costs of $74 million and cash paid for business dispositions of $65 million in fiscal 2019.
Net cash used in financing activities during the first nine months of fiscal 2020 was $305 million as compared to $1,183 million during the comparable period of the prior fiscal year. The $878 million decrease was primarily due to additional borrowings on long-term debt of $552 million, a decrease in payments on long-term debt of $1,590 million, and lower repurchases of common stock and advance payment for accelerated share repurchase of $517 million. This was partially offset by borrowings for the USPS spin transaction of $1,114 million and proceeds from bond issuance of $753 million in the prior fiscal year.
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Capital Resources
See Note 21 - "Commitments and Contingencies" for a discussion of the general purpose of guarantees and commitments. The anticipated sources of funds to fulfill such commitments are listed below and under the subheading "Liquidity."
The following table summarizes our total debt:
As of | ||||||||
(in millions) | December 31, 2019 | March 31, 2019 | ||||||
Short-term debt and current maturities of long-term debt | $ | 1,581 | $ | 1,942 | ||||
Long-term debt, net of current maturities | 7,315 | 5,470 | ||||||
Total debt | $ | 8,896 | $ | 7,412 | ||||
The $1.5 billion increase in total debt during the first nine months of fiscal 2020 was primarily attributed to the new term loan credit agreement in an aggregate principal of $2.2 billion, consisting of three tranches: (i) $500 million maturing on fiscal 2025; (ii) €750 million maturing on fiscal 2022; and (iii) €750 million maturing on fiscal 2023. The proceeds from the new borrowing was used to finance the Luxoft Acquisition. Additionally, we repaid the $500 million Senior Notes due 2020 during the first quarter of fiscal 2020 and $500 million Senior Notes due 2021 during the third quarter of fiscal 2020. We were in compliance with all financial covenants associated with our borrowings as of December 31, 2019 and December 31, 2018.
The maturity chart below summarizes the future maturities of long-term debt principal for fiscal years subsequent to December 31, 2019 and excludes maturities of borrowings for assets acquired under long-term financing and finance lease liabilities. For more information on our debt, see Note 12 - "Debt" to the financial statements.
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The following table summarizes our capitalization ratios:
As of | ||||||||
(in millions) | December 31, 2019 | March 31, 2019 | ||||||
Total debt | $ | 8,896 | $ | 7,412 | ||||
Cash and cash equivalents | 2,560 | 2,899 | ||||||
Net debt(1) | $ | 6,336 | $ | 4,513 | ||||
Total debt | $ | 8,896 | $ | 7,412 | ||||
Equity | 9,101 | 11,725 | ||||||
Total capitalization | $ | 17,997 | $ | 19,137 | ||||
Debt-to-total capitalization | 49.4 | % | 38.7 | % | ||||
Net debt-to-total capitalization(1) | 35.2 | % | 23.6 | % | ||||
(1) Net debt and Net debt-to-total capitalization are non-GAAP measures used by management to assess our ability to service our debts using only our cash and cash equivalents. We present these non-GAAP measures to assist investors in analyzing our capital structure in a more comprehensive way compared to gross debt based ratios alone.
Net debt-to-total capitalization as of December 31, 2019 increased as compared to March 31, 2019, primarily due to the increase in total debt attributed to the Luxoft Acquisition, the decrease in cash and cash equivalents used to pay down Senior Notes, and the decrease in equity resulting from goodwill impairment charges reported during the second quarter of fiscal 2020.
As of December 31, 2019, our credit ratings were as follows:
Rating Agency | Rating | Outlook | Short Term Ratings | |||
Fitch | BBB+ | Negative | F-2 | |||
Moody's | Baa2 | Stable | P-2 | |||
S&P | BBB | Negative | - | |||
Following our announcement in November to explore strategic alternatives for certain of our businesses, Fitch and S&P each affirmed DXC’s credit ratings and revised their ratings outlook to negative from stable. Moody’s identified the strategic alternatives as credit negative and indicated its DXC’s ratings and outlook were unaffected by the announcement.
See Note 21 - "Commitments and Contingencies" for a discussion of the general purpose of guarantees and commitments. The anticipated sources of funds to fulfill such commitments are listed below.
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Liquidity
We expect our existing cash and cash equivalents, together with cash generated from operations, will be sufficient to meet our normal operating requirements for the next 12 months. We expect to continue to use cash generated by operations as a primary source of liquidity, however, should we require funds greater than that generated from our operations to fund discretionary investment activities, such as business acquisitions, we have the ability to draw on our multi-currency revolving credit facility or raise capital through the issuance of capital market debt instruments such as commercial paper, term loans, and bonds. In addition, we also currently utilize and will further utilize our cross currency cash pool for liquidity needs. However, potential future ratings agency actions may impair our ability to access certain segments of the capital markets and there is no guarantee that we will be able to obtain debt financing, if required, on terms and conditions acceptable to us, if at all, in the future.
Our exposure to operational liquidity risk is primarily from long-term contracts which require significant investment of cash during the initial phases of the contracts. The recovery of these investments is over the life of the contract and is dependent upon our performance as well as customer acceptance.
The following table summarizes our total liquidity:
As of | ||||
(in millions) | December 31, 2019 | |||
Cash and cash equivalents | $ | 2,560 | ||
Available borrowings under our revolving credit facility | 4,000 | |||
Total liquidity | $ | 6,560 | ||
Share Repurchases
During the first quarter of fiscal 2018, our Board of Directors authorized the repurchase of up to $2.0 billion of our common stock and during the third quarter of fiscal 2019, our Board of Directors approved an incremental $2.0 billion share repurchase. This program became effective on April 3, 2017 with no end date established. During the nine months ended December 31, 2019, we repurchased 15,933,651 shares of our common stock at an aggregate cost of $736 million. The repurchase included 3,654,544 shares under the accelerated share repurchase ("ASR") agreement at an average price of $54.73 per share. See Note 17 - "Stockholders' Equity" to the financial statements.
Dividends
During the nine months ended December 31, 2019, our Board of Directors declared aggregate cash dividends to our stockholders of $0.63 per share, or approximately $165 million. Future dividends are subject to customary board review and approval prior to declaration.
Off-Balance Sheet Arrangements
In the normal course of business, we are party to arrangements that include guarantees, the receivables securitization facility and certain other financial instruments with off-balance sheet risk, such as letters of credit and surety bonds. We also use performance letters of credit to support various risk management insurance policies. No liabilities related to these arrangements are reflected in our condensed consolidated balance sheets. There have been no material changes to our off-balance-sheet arrangements reported under Part II, Item 7 of our Annual Report on Form 10-K other than as disclosed below and in Note 6 - "Sale of Receivables" and Note 21 - "Commitments and Contingencies" to the financial statements in this Quarterly Report on Form 10-Q.
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Contractual Obligations
With the exception of the new term loan credit agreement in an aggregate principal of $2.2 billion, consisting of three tranches: (i) $500 million maturing during fiscal 2025; (ii) €750 million maturing during fiscal 2022; and (iii) €750 million maturing during fiscal 2023, and repayment of the $500 million Senior Notes due 2020 and $500 million Senior Notes due 2021 as discussed above under the subheading "Capital Resources," there have been no material changes, outside the ordinary course of business, to our contractual obligations since March 31, 2019. For further information see "Contractual Obligations" in Item 7 of Part II of our Annual Report on Form 10-K for the fiscal year ended March 31, 2019.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in accordance with U.S. GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities. These estimates may change in the future if underlying assumptions or factors change. Accordingly, actual results could differ materially from our estimates under different assumptions, judgments or conditions. We consider the following policies to be critical because of their complexity and the high degree of judgment involved in implementing them: revenue recognition, income taxes, business combinations, defined benefit plans and valuation of assets. We have discussed the selection of our critical accounting policies and the effect of estimates with the audit committee of our board of directors. During the three months and nine months ended December 31, 2019, there were no changes to our accounting estimates from those described in our fiscal 2019 Annual Report on Form 10-K except as mentioned in Note 1 - "Summary of Significant Accounting Policies".
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For quantitative and qualitative disclosures about market risk affecting DXC, see "Quantitative and Qualitative Disclosures About Market Risk" in Item 7A of Part II of our Annual Report on Form 10-K for the fiscal year ended March 31, 2019. Our exposure to market risk has not changed materially since March 31, 2019.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated, as of the end of the period covered by this Quarterly Report on Form 10-Q, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of December 31, 2019 because of the material weakness in our internal control over financial reporting described below.
Control Activities
We did not design and implement effective control activities based on the criteria established in the COSO framework. These control deficiencies constitute a material weakness in the aggregate related to reassessing policies and procedures, to determine their continued relevance, as impacted by complex transactions and processes.
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Deficiencies that contributed to the aggregation included:
• | Management did not reassess in a timely manner the control activities related to goodwill impairment upon adoption of ASU 2017-04 which resulted in an immaterial out of period adjustment related to the tax effect of the impairment recognized. |
• | Management did not reassess the control and procedures related to the balance sheet classification of deferred revenue following a large and complex acquisition which resulted in an immaterial out of period adjustment to the balance sheets. |
As a result, we have concluded that there is a reasonable possibility that a material misstatement to our Condensed Consolidated Financial Statements would not be prevented or detected on a timely basis and therefore we concluded that the aggregation of these deficiencies represents a material weakness in our internal control over financial reporting as of December 31, 2019.
Notwithstanding the identified material weakness, management believes that the Condensed Consolidated Financial Statements and related financial information included in this 10-Q fairly present, in all material respects, our balance sheets, statements of operations, comprehensive (loss) income and cash flows as of and for the periods presented.
Remediation Plan
Our remediation efforts are ongoing. Management plans to implement remediation actions to address the control deficiencies that led to a material weakness. The following activities are designed as part of this remediation plan:
• | Appointment of a new senior executive reporting directly to our Chief Financial Officer to lead remediation activities. |
• | Enhance periodic reviews by management to determine if policies, procedures, and related control activities have continued relevance or need updating with a specific focus on complex transactions and processes. |
• | Align the SOX compliance function under the newly appointed Chief Risk Officer. |
• | Periodic reporting of the remediation plan progress to the Audit Committee. |
While we believe the plan will improve the effectiveness of our internal control over financial reporting, we may supplement our remediation activities as our work progresses where appropriate. Our goal is to have enhanced control policies, procedures, processes in place as promptly as practicable. However, due to the nature of the work and subsequent testing required to conclude that a material weakness no longer exists, we may not be in a position to complete our remediation plan and conclude that our internal control over financial reporting is operating effectively until after the end of our current fiscal year.
Changes in Internal Control over Financial Reporting
During the first quarter of fiscal 2020, we adopted ASC 842 effective April 1, 2019, as described in Note 2 - “Recent Accounting Pronouncements” and Note 7 - “Leases” to the financial statements. We implemented a new lease accounting system and redesigned certain processes and controls pertaining to our lease portfolio.
There were no changes in our internal control over financial reporting during the three months ended December 31, 2019 that have materially affected, or are reasonably likely to material affect, our internal control over financial reporting.
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PART II
ITEM 1. LEGAL PROCEEDINGS
See Note 21 - "Commitments and Contingencies" to the financial statements under the caption “Contingencies” for information regarding legal proceedings in which we are involved.
Item 1A. | RISK FACTORS |
Our operations and financial results are subject to various risks and uncertainties, which may materially and adversely affect our business, financial condition, and results of operations, and the actual outcome of matters as to which forward-looking statements are made in this Quarterly Report on Form 10-Q. In such case, the trading price for DXC common stock could decline, and you could lose all or part of your investment. Past performance may not be a reliable indicator of future financial performance and historical trends should not be used to anticipate results or trends in future periods. Future performance and historical trends may be adversely affected by the aforementioned risks, and other variables and risks and uncertainties not currently known or that are currently expected to be immaterial may also materially and adversely affect our business, financial condition, and results of operations or the price of our common stock in the future. Apart from the risk factors disclosed below, there have been no material changes in the three months ended December 31, 2019 to the risk factors described in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2019 and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarterly periods ended June 30, 2019 and September 30, 2019.
We have identified a material weakness in our internal control over financial reporting. Without effective internal control over financial reporting, we may fail to detect or prevent a material misstatement in our financial statements, which could materially harm our business, our reputation and our stock price.
While we have not identified any material misstatements in our previously reported consolidated financial statements, our management identified a material weakness in our internal control over financial reporting as of December 31, 2019. See "Item 4. Controls and Procedures." Without effective internal control over financial reporting, we may fail to detect or prevent a material misstatement in our financial statements. In that event, we may be required to restate our financial statements. A restatement or an unremediated material weakness could result in a loss of confidence in us by our investors, customers, regulators and/or counterparties. In addition, if we are unable promptly to remediate the material weakness identified above, or if we were to conclude in the future that we have one or more additional weaknesses, our investors, regulators, customers and/or counterparties may lose confidence in our reported financial information. Additionally, management may be required to devote significant time and incur significant expense to remediate the material weakness, and management may not be able to complete such remediation in a timely manner. Any of the foregoing could materially harm our business, our reputation and the market price of our common stock.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Unregistered Sales of Equity Securities
None during the period covered by this report.
Use of Proceeds
Not applicable.
Issuer Purchases of Equity Securities
The following table provides information on a monthly basis for the quarter ended December 31, 2019, with respect to the Company’s purchase of equity securities:
Period | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs | ||||||
October 1, 2019 to October 31, 2019 | — | $— | — | $1,874,024,787 | ||||||
November 1, 2019 to November 30, 2019 | 848,953 | $36.72 | 848,953 | $1,842,853,650 | ||||||
December 1, 2019 to December 31, 2019 | 1,504,899 | $36.68 | 1,504,899 | $1,787,691,389 | ||||||
On April 3, 2017, DXC announced the establishment of a share repurchase plan approved by the Board of Directors with an initial authorization of $2.0 billion for future repurchases of outstanding shares of DXC common stock. On November 8, 2018, DXC's Board of Directors approved an incremental $2.0 billion share repurchase. An expiration date has not been established for this repurchase plan.
On June 13, 2019, DXC entered into an ASR agreement with a third-party financial institution by advancing $200 million including a $100 million prepayment. At inception, the ASR was initially settled by delivery of 1,849,194 shares of common stock to the Company. During the second quarter of fiscal 2020, DXC received an additional 1,805,350 shares of common stock. In total, 3,654,544 shares of common stock were repurchased under the ASR for $200 million.
Share repurchases may be made from time to time through various means, including in open market purchases, 10b5-1 plans, privately-negotiated transactions, accelerated stock repurchases, block trades and other transactions, in compliance with Rule 10b-18 under the Exchange Act, as well as, to the extent applicable, other federal and state securities laws and other legal requirements. The timing, volume, and nature of share repurchases pursuant to the share repurchase plan are at the discretion of management and may be suspended or discontinued at any time.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
The following exhibits are filed with this report.
Exhibit Number | Description of Exhibit |
2.1 | |
2.2 | |
2.3 | |
2.4 | |
2.5 | |
2.6 | |
2.7 | |
2.8 | |
2.9 | |
2.10 | |
2.11 | |
2.12 | |
2.13 | |
2.14 | |
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2.15 | |
2.16 | |
2.17 | |
2.18 | |
2.19 | |
2.20 | |
2.21 | |
2.22 | |
3.1 | |
3.2 | |
10.1 | |
10.2 | |
10.3 | |
31.1 | |
31.2 | |
32.1 | |
32.2 | |
101 | Interactive Data Files |
101.SCH | XBRL Taxonomy Extension Schema |
101.CAL | XBRL Taxonomy Extension Calculation |
101.LAB | XBRL Taxonomy Extension Labels |
101.PRE | XBRL Taxonomy Extension Presentation |
104 | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DXC TECHNOLOGY COMPANY | |||
Dated: | February 7, 2020 | By: | /s/ Neil A. Manna |
Name: | Neil A. Manna | ||
Title: | Senior Vice President, Corporate Controller Principal Accounting Officer | ||
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