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Analysis of CSC ‘s Q1 FY2014 earnings release increased our level of concern about the company’s outlook and direction. It confirmed our misgivings, and those of many of our correspondents, about the underlying level of sustainable profit in today’s CSC.
As ever, CEO Mike Lawrie gave a professional performance during the Analyst Conference focusing on the positive aspects of the Q1 results and talking up CSC’s prospects. In fact, just listening to Mr. Lawrie without looking at any numbers gave the impression everything was going to plan, the only problem being the failure of the recently-departed Head of GBS to manage his business adequately. As usual, Mr. Lawrie was helped by a series of soft questions from the analysts who showed their usual level of docility.
Nor was there anything remarkable or exciting about the company’s Q1FY2015 results release. CSC once more exceeded the Analysts’ consensus on its profitability and, unusually, did manage to exceed the consensus on Q1 revenue; also the rate of revenue decline slowed.
However, looking beyond Mr Lawrie’s positivity and the company’s exceeding the analysts’ expectations, there were items which gave us real concern:
- · Revenue continued to decline, being 2% lower, in constant currency, than the equivalent figure of the previous year.
- · Total Operating margin dropped to 9.4% from 10.2%. NPS, which is largely a cost-plus business, saw its margin grow by 2.7% to 14.7%, but GBS and GIS, whose delivery can carry greater financial risks suffered margin reductions.
- · EBIT for Q1 FY2015 dropped to 7.7% from 8.3% a year ago. This was despite the cost take-out and involuntary vacation in the quarter; also despite a change in pension accounting policy which yielded a profit boost of US$21 million in the quarter, and despite Q1 FY2015 having an extra week, which yielded a one-off benefit of at least US$ 39million and maybe anything up to US$119 million.
- · Investments (as defined by CSC) of US$105m continue to focus on HR and Finance systems, customer committed savings, restructuring and next generation offerings. Share buybacks totaled US$148million and dividends distributed US$29million. This investment approach speaks volumes about CSC’s intentions.
- · New Business awards for the quarter were a disappointing US$2.7 billion, being 15% below the level required to simply replenish the pipeline. Yet another indicator of a shrinking business.
It is a pity no analyst asked about this; unsurprisingly CSC did not volunteer the information.
We estimate that these one-offs could have accounted for US$96 million of EBIT. If so this would bring underlying EBIT down to US$152 million, or 4.7% rather than the reported US$248 million or 7.7%. A significant difference that is 46% lower than last year and needs explaining.
This difference is made up of three items;
- US$21 million Pension accounting change (Note 1)
- US$60 million impact of Extra Week (Note 2)
- US$15 million impact of Involuntary Vacation (Note 3)
Note 1 - Figure given by P Saleh in Q&A session.
Note 2 - P
Saleh in Q&A session said GIS impact was US$39m: that GBS and NPS impact
impossible to calculate, but could be anywhere in a range between zero and US$
80million. We have assumed US$21 million within this range.
Note 3 – We cannot calculate the total impact of forced or involuntary vacation because we do not know the revenue impact. However, we can estimate the impact on the SG&A line alone, as these resources do not directly generate revenue. We calculate the impact as approx US$5 million per day of forced or involuntary vacation. For the sake of this exercise we have assumed that each SG&A resource took three days of “involuntary” vacation in Q1 FY2015, meaning vacation they would not have chosen to take without a directive from the company.
So where does this leave matters?
It reinforced and heightened our concerns about the business fundamentals underlying the published results.
For shareholders, one would be hoping Mr. Lawrie is close to concluding the rumoured sale; because we see nothing to be optimistic about in the company's prospects, and the share price range may not be sustained. In fact it has started to fall.
For employees, the concern is more bad news to come as Mr. Lawrie uses the only business tool he seems familiar with; cost and people take out to maintain profits.
The bottom line is:
The breaking down of a once great enterprise continues.