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CSC Q1 FY 2014 Results: Progress on Cost Take-Out; Too Early To Tell For Future Growth

CSC recently announced results for Q1 FY 2014, ending June 28, 2013:

  • Revenues were $3,260m, down 10.3% y/y on restated Q1 FY 2013, down 6.1% at CS/CC excluding a NHS milestone payment
  • Operating margin was 9.3%, up 531 bps y/y
  • EBIT margin was 7.4%, up 536 bps y/y.

Revenue guidance for FY 2014 is flat or slightly negative growth in CC, with high single to low double digit decline in NPS offset by growth in Commercial.

CSC continues to divest operations, most recently its Applied Technology Division ($178m gross proceeds) and flood insurance BPO business ($47m).

CSC is now in the second half of the ‘Fix the Foundation’ phase of its multi-year transformation plan. It is making good progress with its cost take-out initiatives: the ~$175m achieved in Q1 was ahead of plan, and the target for FY 2014 has been increased to $500m. The company expects to continue to spend $30m-$40m per quarter on restructuring, particularly in its European operations.

Under Lawrie’s leadership, CSC is now more efficient and has stronger discipline around contract management. The balance sheet is stronger (net debt to capital ratio is 13.3%, improved from 31.5% a year ago).

To give a sense of the extent of the restructuring at CSC in the last 18 months: when Lawrie arrived as CEO, CSC had ~370 VPs; it now has 75, of whom ~50 are new. And there's also a lot of new blood in management layers below.

But what progress is being made in the pillars of the turnaround plan that will drive any future profitable growth? And when should we expect to see bookings growth?

Q1 commercial bookings were down 33% y/y- though excluding one large European win in Q1 FY 2013, commercial bookings were up 2%, led by Asia (>300%) and the Americas, >30%.

CSC is pinning its hopes in the short term on its commercial sector business, driven by growth in cloud, cyber, big data and applications. Management highlights 16% y/y growth in Q1 in cyber , 27% in commercial cloud, 9% in industry software & solutions, and 30% in BPO.

The NPS business is more challenging than CSC anticipated. In the face of fewer federal sector contract opportunities, CSC is relying on improving its win rate.

The company is forming strategic partnerships to expand its market coverage: it also announced today a global strategic partnership with AT&T which will involve:

  • AT&T running CSC's communication network
  • CSC merging its cloud hardware infrastructure with AT&T's, providing global scale to build out its cloud offerings
  • CSC assisting AT&T and AT&T's clients in modernizing their application portfolio and moving those applications to the Cloud.

CSC has been expanding its sales capabilities, adding ~500 account managers who are being trained and incentivized to cross and up-sell, plus 300 sales people. Management expects this increased sales coverage will start driving bookings growth in fiscal H2, including bookings associated with cross-sell.

Management referred to encouraging signs in its commercial pipeline for BPO, applications-led opportunities, and cloud-based deals, the latter up over 200% to over $2bn. How well positioned is CSC to win some of these opportunities? CSC historically targeted large multi-year opportunities, but deals of the size of the $140m insurance BPO contract it closed last week are now rare. CSC claims it is repositioning to be able to respond more efficiently and effectively to smaller opportunities. Moving from a heritage of long, complex outsourcing deals to smaller shorter-duration opportunities - where the competitive environment is perhaps somewhat different from what CSC has been used to – may prove to be particularly challenging, and for a number of reasons…

One area where CSC still has a lot to do is in expanding its portfolio of higher margin industry-specific software and business process services. This will require significant investment but it would be a major aspect of making CSC a fundamentally different company from its legacy. This could also be a challenging part of the company’s transformation.

Finally, we would like to know the reasons for CSC’s confidence that it will begin to see a recovery in its European operations from the end of the year.

We will be updating our Key Vendor Assessment on CSC next month, and would be interested in hearing any client observations.

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