Viewed from a certain angle, Falls Church, Va.-based Computer Sciences Corp. looks like a case study of everything people think is wrong with American capitalism: Misleading investors through rosy accounting. Golden parachutes and excessive executive pay. Ruthless cost cutting and outsourcing of jobs overseas. Plumping up share prices through stock buybacks, special dividends and other feats of financial engineering.
Yet from another angle you can see in this Beltway information services giant everything that has made American business successful, competitive and resilient: a willingness to acknowledge mistakes and failure, an intolerance for mediocrity and inefficiency, an embrace of globalization, an ability to adapt to changing technology and market conditions, a laser-like focus on customers and investors.
The current act in Computer Sciences’ corporate drama is largely being written by Mike Lawrie, a brash 26-year veteran of IBM who rose to become its top salesman. Having participated in IBM’s successful transformation in the late 1990s, Lawrie set out to try his own hand as a corporate turnaround specialist, first at Siebel Systems, where he lasted less than a year before falling out with its founder, and then at the British software firm Misys, which he sold to private-equity investors for a handsome premium five years later.
When Lawrie arrived in Falls Church in March 2012, CSC was in turmoil. The company was facing $2 billion in losses and write-downs from a troubled contract to computerize patient records for Britain’s National Health Service. The Securities and Exchange Commission was on the verge of charging the company with accounting lapses and failing to disclose the problems with the NHS contract.
Closer to home, CSC had performed so badly on a contract to modernize the computer system at the Internal Revenue Service that at one point the agency had mistakenly sent out $300 million in fraudulent tax refunds. The Air Force was preparing to write off $1 billion it paid CSC for a new logistics management system that never worked. Meanwhile, in its commercial business, CSC’s technology and cost structure had become uncompetitive. It trailed rivals in moving work to India and other lower-cost locations while failing to anticipate the shift toward cloud computing and standardized software.
As a result of these missteps, when Lawrie arrived CSC was about to report a $4 billion net loss for the year. Its stock, which had been trading as high as $56 a year earlier, had fallen as low as $23 per share. The board of directors had finally fired the previous chief executive, Michael Laphen, a 26-year veteran, who nonetheless walked away with an $11 million severance package and retirement benefits estimated at nearly $1 million a year.
“We were close to slipping under the waves,” Lawrie said.
What he found was a corporate culture fixated on revenue growth rather than creating value for customers and shareholders. The standard for success was best efforts, not best results. People below were unwilling to deliver bad news to those at the top — and those at the top who were unwilling to receive it. “There was no urgency, no accountability,” he said.
Lawrie also found a company highly decentralized in its management and structure. Business units were free to do their own procurement, structure their own contracts, chose their own technology, adopt their own business practices and craft their own compensation incentives. There was no unifying strategy or vision.
“When I took my first look at the company before taking the job,” Lawrie said, “honestly I couldn’t figure it out.”
A company’s rise
Computer Sciences Corp. traces its roots to the early years of the computer age. The company, originally based in the Los Angeles area, was founded in 1959 by Roy Nutt, an IBM engineer who was part of the team that created the computer language Fortran, and Fletcher Jones, who had managed the computer center at North American Aviation, an aerospace contractor. Together, Nutt and Jones wrote the system software for every major mainframe computer, making it possible for more enterprises to computerize their operations.
In the 1960s, CSC switched from serving computer makers to serving computer users — in particular, the biggest user of all: the federal government. In the 1970s, CSC became a big player in time-sharing, renting its mainframe computers to customers by the minute. In the 1980s, it rode the wave of systems integration, helping companies tie their various computer systems together.
It was during the 1990s, however, when CSC really took off. Nearly every large company, along with many government agencies, moved to outsource information technology operations — and with it, their existing hardware, software and employees. Companies such as IBM, EDS and CSC competed for these multiyear, multibillion-dollar contracts. Shortly after moving its headquarters to the Washington region in 2008, CSC’s revenue topped $16 billion, with 95,000 employees worldwide and a balance sheet loaded with its customers’ computer systems, each one custom designed and programmed.
Getting contracts was one thing, executing on them was another, as the IRS, the Air Force and Britain’s National Health Service would discover. The common rap on CSC was that while it was pretty good at running data centers or programming software that accomplished a specific task, it was much weaker in understanding its customers’ overall business needs and processes and designing effective computer solutions.
CSC, of course, was hardly the only IT service company to have over-promised and under-delivered. But soon after Lawrie and his new chief financial officer, Paul Saleh, settled in, they identified 40 contracts — representing about one-third of the company’s business — that were in trouble, either because of execution failures or because they had fallen short of profitability goals. To fix them they would have to fix the company first.
Their approach was bold and ruthless. Every member of the top management team save one (the general counsel) was replaced — in a few cases, more than once. Twelve layers of management were reduced to seven, with hundreds of vice presidents and directors losing their titles. Centralized purchasing and financial systems were put in place. At headquarters and elsewhere, private offices were torn down in favor of open-floor formats. Regular customer-satisfaction surveys were instituted, with the results used in setting management bonuses.
Computer centers were closed, consolidated or moved to lower-cost locations, both in the United States (Pittsburgh, Bossier City, La.) and abroad (India, Eastern Europe, Vietnam). Managers were told to evaluate employees based on performance, not just effort, with suggestions of a bell-curve-like grading system in which 40 percent of employees would be rated as “below expectations.” Thousands were laid off, denied promotions or encouraged to leave, reducing worldwide employment to 68,500 (including 7,000 in the Washington area, about half of what it once was). “Non-core” divisions, both profitable and unprofitable, were sold off even as other companies were acquired to bolster offerings in cloud computing and cybersecurity.
As for those troubled or unprofitable contracts, most were renegotiated or restructured, including the big one with the British health agency, which now uses CSC software in a growing number of its hospitals and regions. Some corporate clients were persuaded to take activities they had outsourced in-house again. Other contracts were simply allowed to expire.
Then, after years of negotiation, CSC last month finally settled with the SEC. Although it did not admit or deny that its executives had conspired to mislead investors about the troubled NHS contract, as revealed in e-mails uncovered by investigators, the company agreed to restate its financial results and pay a $190 million fine — on top of the $125 million spent on legal and accounting fees during the investigation. At the insistence of the government, former CEO Laphen agreed to pay a fine of $750,000 and return $3.7 million in bonus money he had received as a result of the inflated earnings.
Stock surges with turnaround
Computer Sciences Corp. today is considerably smaller, more focused and more profitable than it was three years ago. In the fiscal year ending in March, revenue was just over $12 billion, down from nearly $15 billion in 2012. Annual operating costs have been reduced by more than $3 billion. And if you’re willing to look past all the one-time restructuring and settlement charges and asset write-downs, which continue to be significant, what you find is that a company that three years ago was barely breaking even now posts an annual operating profit of close to $1 billion.
The big beneficiaries of this turnaround have been CSC’s shareholders, whose stock is trading at $65 per share, more than twice what it was when Lawrie took over. The overall rise in the stock market, plus the $3 billion in company funds committed to stock buybacks and special dividends, could explain about half of that increase. But the rest is certainly a reflection of the turnaround in CSC’s operations and Wall Street’s confidence in Lawrie.
Lawrie himself has also been a big winner. His pay package last year was valued at $15.4 million, including a $1.8 million bonus tied to financial goals that would normally be considered rounding errors at a $12 billion company: a $100 million increase in revenue, a $75 million increase in operating income and an $11 million increase in free cash flow. The pay package also included a grant of stock valued at $8.6 million for exceeding the rather modest goal of a 4 percent increase in operating earnings per share. Those grants brought the total value of Lawrie’s stake in CSC stock, after three years, to $56 million.