PROPOSAL 2:  APPROVAL OF 2004 INCENTIVE PLAN

The Board has adopted the 2004 Incentive Plan (the “2004 Plan”) on June 7, 2004 and is submitting it for approval at the Annual Meeting. For more than 20 years, the Board has adopted a new equity incentive plan approximately every three years. Each of our plans has been approved by CSC stockholders. The two most recent plans were adopted in 2001 and 1998.

Our annual “net burn rate” (options granted minus options canceled) during the past three fiscal years has averaged 3,008,000 shares, or 1.6% of the outstanding CSC stock. As of June 7, 2004, only 882,407 shares of CSC stock remained available under our plans for new grants of equity incentives. The 2004 Plan authorizes an additional 9,000,000 shares for this purpose. The Board believes this amount should be sufficient for the next three years.

Potential Dilution

One common method of measuring the potential dilution attributable to equity incentive plans is to divide the sum of (i) the number of shares authorized for issuance under future awards plus (ii) the number of shares subject to outstanding awards, by the number of shares outstanding. CSC’s potential dilution increases each time we adopt a new equity incentive plan, and then decreases as shares are issued under the plan and as the number of shares outstanding increases.

The 2004, 2001 and 1998 plans originally authorized 9,000,000, 8,000,000 and 9,000,000 additional shares of CSC stock, respectively, for issuance under future awards. Although the number of shares outstanding has increased significantly during the last nine years, the decreases in CSC’s potential dilution following adoption of its three most recent plans has primarily been attributable to stock option exercises. Over the last three fiscal years, CSC’s stock price has been depressed and there have been an unusually low number of option exercises. The total number of shares issued upon the exercise of options during the three fiscal years preceding adoption of the 2004, 2001 and 1998 plans was 2,595,884, 5,941,046 and 9,105,364, respectively.

The effect of the unusually low exercise activity during the past three years can be seen in a comparison of the potential dilution prior to the adoption of our three most recent plans. As of the fiscal year-end preceding the adoption of the 2004, 2001 and 1998 plans, the potential dilution was 11.9%, 10.3% and 8.8% respectively. Including the additional shares subsequently authorized by 2004, 2001 and 1998 plans, the pro forma potential dilution increased to 16.7%, 15.0% and 14.5%, respectively. The 2004 Plan authorizes essentially the same number of additional shares as the 2001 and 1998 plans, and accounts for essentially the same percentage increase in potential dilution as the 2001 plan and a smaller percentage increase than the 1998 plan. Because of the dramatic decrease in stock option exercises, however, CSC’s potential dilution is significantly greater after adoption of the 2004 Plan, than after adoption of the 2001 and 1998 plans.

Option exercise activity has increased substantially, however, since fiscal 2004 year-end. In the approximately two-month period between year-end and the adoption of the 2004 Plan on June 7, 2004, options to purchase 319,785 shares were exercised. This represents an increase of more than 120% over the average rate of exercise during the last three fiscal years. Immediately following the adoption of the 2004 Plan on June 7, 2004, there were 9,882,407 shares available for the grant of future stock-based incentives, and 20,858,800 shares of CSC stock subject to outstanding options, which had a weighted average exercise price of $39.89.

The Board believes the number of shares authorized for issuance under the 2004 Plan should be determined by the appropriate annual net burn rate, rather than by potential dilution, which is significantly affected by events outside of CSC’s control. As mentioned above, the average annual net burn rate during the past three years has been slightly more than 3,000,000 shares, and the Board believes this number of shares represents a reasonable average annual budget for the next three years. Staying within this budget will likely require an increasing conservatism in our grants of equity incentives, given historic growth trends in CSC’s employee base (45,000 employees in 1998; 68,000 employees in 2001; and 90,000 employees in 2004).

Plan Summary

The 2004 Plan is attached as Appendix B to this Proxy Statement. The following summary of the 2004 Plan is qualified in its entirety by reference to the full text of the Plan.

Shares Available for Issuance

The maximum number of shares of CSC stock that may be issued pursuant to awards granted under the 2004 Plan is 9,000,000, subject to certain adjustments for corporate transactions, as described in “Adjustments” below. Shares of CSC stock issued under the 2004 Plan may consist of newly issued shares, treasury shares and/or shares purchased in the open market or otherwise. Only shares of CSC stock actually issued pursuant to awards granted under the 2004 Plan will be counted against the authorized shares. If an award is settled or terminates by expiration, forfeiture, cancellation or otherwise without the issuance of all shares originally covered by the award, then the shares not issued will again be available for use under the 2004 Plan. If the exercise or purchase price of an award or the tax withholding requirements attributable to an award are satisfied by the delivery of CSC stock to CSC, then the number of shares so delivered or withheld will be subtracted from the number of shares issued pursuant to the award for purposes of counting shares used.

All Employees Eligible

Each employee of CSC or any of its subsidiaries is eligible to be considered for the grant of awards under the 2004 Plan. As of June 11, 2004, there were approximately 90,000 eligible employees.

Administration by Independent Committee

The 2004 Plan will be administered by a committee of the Board (the “Committee”) consisting of three or more directors, each of whom is:

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“independent” for purposes of CSC’s Corporate Governance Guidelines;

 

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a “non-employee director” for purposes of SEC Rule 16b-3(b)(3); and

 

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an “outside director” for purposes of Section 162(m) of the Internal Revenue Code.

 

The Committee will have full and final authority to select the employees to whom awards will be granted under the 2004 Plan, to grant awards and to determine the terms and conditions of those awards.

Types of Awards

The 2004 Plan provides for the grant of:

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stock options;

 

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restricted stock;

 

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restricted stock units (“RSUs”); and

 

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performance awards, payable in restricted stock, RSUs, shares of CSC stock, cash or other property, or any combination of the foregoing.

 

Subject to the 2004 Plan, the Committee will determine the terms and conditions of each award, which will be set forth in an award agreement executed by CSC and the participant.

 

Stock Options.  The 2004 Plan authorizes the Committee to grant incentive stock options and nonqualified stock options. The terms and conditions of the stock options will be determined by the Committee, subject to the requirements of the 2004 Plan. Among those requirements are the following:

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No Discount Options.  The exercise price per share cannot be less than the fair market value of a share on the date of option grant;

 

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No Repricing.  The 2004 Plan prohibits any adjustment to an outstanding option that reduces, or has the effect of reducing, the exercise price (other than in connection with certain corporate transactions, as described in “Adjustments” below), unless the adjustment is approved by CSC’s stockholders;

 

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Maximum 10-Year Term.  The option cannot be exercised after the 10th anniversary of the option grant date; and

 

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Minimum 3-Year Vesting.  The option cannot provide for scheduled vesting in full prior to the 3rd anniversary of the option grant date, although it may provide for accelerated vesting under specified circumstances.

 

Subject to the other provisions of the 2004 Plan, the exercise price of an Option may be paid in such form as the Committee may specify in the applicable award agreement, including by the delivery of cash, shares of CSC stock and/or other consideration (including, where permitted by law and the Committee, awards) having a fair market value on the exercise date equal to the total exercise price.

Restricted Stock and Restricted Stock Units.  The 2004 Plan authorizes the Committee to grant awards of restricted stock and RSUs with time-based vesting or performance-based vesting. An RSU represents the right to receive a specified number of shares of CSC stock, or cash based on the fair market value of those shares, upon vesting or at a later date permitted in the award agreement. The terms and conditions of the restricted stock and RSUs will be determined by the Committee, subject to the requirements of the 2004 Plan. Among those requirements are the following:

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Minimum 3-Year Time-Based Vesting.  Restricted stock and RSUs with time-based vesting cannot provide for scheduled vesting in full prior to the 3rd anniversary of the award grant date, although they may provide for accelerated vesting under specified circumstances; and

 

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Voting and Dividend Rights.  Unless the Committee determines otherwise, all restricted stock will have full voting and dividend rights, and all RSUs will have full dividend equivalent rights.

 

Performance Awards.  The 2004 Plan authorizes the Committee to grant performance awards payable in restricted stock, RSUs, shares of CSC stock, cash or other property, or any combination of the foregoing, based upon the achievement of specified performance goals during a specified performance period, which may be not less than one year, except with respect to new hires. Subject to the 2004 Plan, the performance goals, performance period and other terms and conditions applicable to performance awards will be specified by the Committee and set forth in the award agreement. Except as provided in the 2004 Plan, performance awards will be paid or distributed only after the end of the performance period.

Performance-Based Awards.  Section 162(m) of the Internal Revenue Code limits CSC’s federal income tax deduction for compensation paid to any of the officers named in its proxy statement. The limit is $1 million per officer per year, with certain exceptions. This deductibility cap does not apply to qualifying “performance-based compensation,” if approved in advance by CSC’s stockholders. It is intended that Performance-Based Awards granted under the 2004 Plan will qualify as deductible performance-based compensation if CSC stockholders approve the 2004 Plan and it is otherwise administered in compliance with Section 162(m).

A grant to a CSC officer of a performance award, or of restricted stock or RSUs with performance-based vesting, may be designated by the Committee as a “Performance-Based Award.” The performance goals for a Performance-Based Award must be based on one or more of the following and determinedpursuant to an objective formula: (i) contract awards; (ii) backlog; (iii) market share; (iv) revenue; (v) sales; (vi) days’ sales outstanding; (vii) overhead; (viii) other expense management; (ix) operating income; (x) operating income margin; (xi) earnings (including net earnings, EBT, EBIT and EBITDA); (xii) earnings margin; (xiii) earnings per share; (xiv) cash flow; (xv) working capital; (xvi) book value per share; (xvii) improvement in capital structure; (xviii) credit rating; (xix) return on stockholders’ equity; (xx) return on investment; (xxi) return on assets; (xxii) total shareholder return; or (xxiii) stock price.

Any performance goal may be used to measure the performance of the employee, one or more CSC business units, or CSC as a whole, and may be measured relative to a peer group or index, or relative to target or budgeted amounts. Any performance criteria may be adjusted to omit the effects of extraordinary items, gain or loss on the disposal of a business segment (other than provisions for operating losses or income during the phase-out period), unusual or infrequently occurring events and transactions that have been publicly disclosed and the cumulative effects of changes in accounting principles, all as determined in accordance with generally accepted accounting principles.

No Performance-Based Award granted under the 2004 Plan will be payable unless the Committee certifies in writing that the applicable performance goals have been satisfied. The Committee may not increase the value of a Performance-Based Award above the maximum value determined under the performance formula, but may retain the discretion to reduce the value below that maximum value.

Limitation on Issuance of Full Value Shares

No more than 50% of the total number of CSC shares authorized for issuance under the 2004 Plan may be issued as restricted stock or delivered in payment of an RSU or performance award (collectively, “full-value shares”).

Individual Award Limits

During any fiscal year, no employee may be granted under the 2004 Plan:

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performance awards with a maximum aggregate value of more than $5,000,000 (including all cash payable, the fair market value of all shares issuable as shares of CSC stock or restricted stock, or pursuant to RSUs, and the fair market value of all other property); or

 

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stock options, restricted stock and RSUs (excluding restricted stock and RSUs issued pursuant to a performance award) with respect to an aggregate of more than 750,000 shares of CSC stock (or cash amounts based on the fair market value of that number of shares).

 

Transferability

Unless the Committee determines otherwise:

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no award, and no shares of CSC stock subject to an outstanding award as to which any applicable restriction, performance or deferral period has not lapsed, may be sold, or transferred except by will or the laws of descent and distribution, and

 

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each award is exercisable during the employee’s lifetime only by the employee or, if permissible under applicable law, by his or her guardian or legal representative.

 

Change in Control

Unless an award agreement shall specify otherwise, upon the date of a change in control of CSC:

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all outstanding options will become fully vested and exercisable;

 

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all restrictions applicable to outstanding restricted stock will lapse in full;

 

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all outstanding RSUs will become fully vested; and

 

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all performance awards will be considered earned and payable at the greater of (i) their value based on actual levels of achievement to date or (ii) their target value (prorated, in each case, if the change in control occurs during the performance period), and will be immediately paid or settled.

 

Adjustments

If there is a reorganization, merger, consolidation, recapitalization, restructuring, reclassification, dividend (other than a regular, quarterly cash dividend) or other distribution, stock split, reverse stock split or similar transaction, or a sale of substantially all of CSC’s assets, then, unless the terms of the transaction provide otherwise, the Committee will make such adjustments as it deems appropriate and proportionate in:

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the number and type of shares subject to outstanding awards granted under the 2004 Plan, and the exercise or purchase price per share;

 

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the maximum number and type of shares authorized for issuance under the 2004 Plan; and

 

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the maximum number and type of shares issuable pursuant to awards granted under the 2004 Plan to any employee during any fiscal year.

 

Plan Amendments

The Board of Directors may amend or terminate all or any part of the 2004 Plan at any time and in any manner, subject to the following:

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CSC stockholders must approve any amendment or termination if (i) stockholder approval is required by the SEC, New York Stock Exchange or any taxing authority, or (ii) the amendment or termination would materially increase the benefits accruing to employees, increase the maximum number of shares which may be issued under the 2004 Plan, materially modify the 2004 Plan’s eligibility requirements or in any way modify the prohibition on repricing options; and

 

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employees must consent to any amendment or termination that would impair their rights under outstanding awards.

 

The Committee may amend the 2004 Plan at any time and in any manner as may be necessary for the 2004 Plan to conform to local rules and regulations in any jurisdiction outside the United States. The Committee may amend the terms of any outstanding award, but no such amendment may impair the rights of any employee without his or her consent.

Plan Duration.  The 2004 Plan became effective upon its adoption by the Board of Directors on June 7, 2004, but no awards may be granted under the 2004 Plan until it has been approved by CSC stockholders. No award may be granted under the 2004 Plan after June 7, 2014, but any award granted prior to that date may extend beyond that date.

New Plan Benefits.  Because benefits under the 2004 Plan will depend on the Committee’s actions and the fair market value of CSC stock at various future dates, it is not possible to determine the benefits that will be received by executive officers and other employees if the 2004 Plan is approved by CSC stockholders.

Federal Income Tax Treatment

The following is a brief description of the effect of U.S. federal income taxation upon an employee and CSC with respect to the grant and exercise of awards under the 2004 Plan, based on federal income tax laws in effect on the date hereof. The following is only a summary and therefore is not complete, does not discuss the income tax laws of any state or foreign country in which an employee may reside, and is subject to change. Employees granted awards under the 2004 Plan should consult their own tax advisors regarding the specific tax consequences to them of participating in the 2004 Plan.

Incentive Stock Options.  Pursuant to the 2004 Plan, employees may be granted stock options that are intended to qualify as “incentive stock options” under the provisions of Section 422 of the Internal Revenue Code. Except as described in the following two sentences, the employee is generally not taxed and CSC is not entitled to a deduction on the grant or exercise of an incentive stock option, provided the option is exercised while the employee is employed by CSC or its subsidiaries, or within three months following termination of employment (one year if termination is due to permanent disability). The amount by which the fair market value of the shares acquired upon exercise of the option exceeds the exercise price will be included as a positive adjustment in the calculation of the employee’s “alternative minimum taxable income” in the year of exercise. The “alternative minimum tax” imposed on individual taxpayers is generally equal to the amount by which a specified percentage of the individual’s alternative minimum taxable income (reduced by certain exemption amounts) exceeds his or her regular income tax liability for the year.

If the employee disposes of shares acquired upon exercise of an incentive stock option at any time within one year after the date of exercise or two years after the date of grant of the option (such a disposition is referred to as a “disqualifying disposition”), then the employee will recognize:

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capital gain in an amount equal to the excess, if any, of the sales price over the fair market value of the shares on the date of exercise;

 

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ordinary income in an amount equal to the excess, if any, of the lesser of the sales price or the fair market value of the shares on the date of exercise over the exercise price of the option; and

 

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capital loss equal to the excess, if any, of the exercise price over the sales price.

 

In the event of a disqualifying disposition, CSC will generally be entitled to a deduction in an amount equal to the amount of ordinary income recognized by the employee.

If the employee sells shares acquired upon exercise of an incentive stock option at any time after the first anniversary of the date of exercise and the second anniversary of the date of grant of the option, then the employee will recognize long-term capital gain or loss equal to the difference between the sales price and the exercise price of the option, and CSC will not be entitled to any deduction.

Nonqualified Stock Options.  Pursuant to the 2004 Plan, employees may be granted stock options that do not qualify for treatment as “incentive stock options” (referred to as “nonqualified stock options”). The grant of a nonqualified stock option is also generally not a taxable event for the employee. Upon exercise of a nonqualified stock option to purchase shares, the employee will generally recognize ordinary income in an amount equal to the excess of the fair market value of the shares on the date of exercise over the exercise price, and CSC will be entitled to a deduction equal to such amount. A subsequent disposition of the shares will give rise to gain or loss equal to the difference between the sales price and the sum of the exercise price paid with respect to the shares plus the ordinary income recognized with respect to the shares. Any gain or loss on the subsequent disposition of shares acquired through the exercise of a nonqualified stock option will generally be treated as a long-term or short-term capital gain or loss, depending on whether the holding period for the shares exceeds one year at the time of the disposition.

Restricted Stock.  Pursuant to the 2004 Plan, employees may be granted restricted stock. Unless the employee makes a timely election under Section 83(b) of the Internal Revenue Code, he or she will generally not recognize any taxable income until the restrictions on the shares expire or are removed, at which time the employee will recognize ordinary income in an amount equal to the excess of the fair market value of the shares at that time over the purchase price for the restricted shares, if any. If the employee makes an election under Section 83(b) within 30 days after receiving shares of restricted stock, he or she will recognize ordinary income on the date of receipt equal to the excess of the fair market value of the shares on that date over the purchase price for the restricted shares, if any. CSC will generally be entitled to a deduction equal to the amount of ordinary income recognized by the employee.

Restricted Stock Units.  Pursuant to the 2004 Plan, employees may be granted RSUs. The grant of an RSU is generally not a taxable event for the employee. In general, the employee will not recognize any taxable income until the shares of CSC stock subject to the RSU (or cash equal to the value of such shares) are distributed to him or her without any restrictions, at which time the employee will recognize ordinary income equal to the excess of the fair market value of the shares (or cash) at that time over the purchase price for the shares, if any. CSC will generally be entitled to a deduction equal to the amount of ordinary income recognized by the employee.

Performance Awards.  Pursuant to the 2004 Plan, employees may be granted performance awards. The grant of a performance is generally not a taxable event for the employee. Upon payment of a performance award, the employee will recognize ordinary income equal to the fair market value of any unrestricted stock (or cash) received. If a performance award is payable in whole or part by the grant of restricted stock or RSUs, the tax treatment is as described in the two preceding paragraphs. CSC will generally be entitled to a deduction equal to the amount of ordinary income recognized by the employee.

Withholding of Taxes.  Generally, CSC will be required to withhold applicable taxes with respect to any ordinary income recognized by an employee in connection with awards granted under the 2004 Plan. The employee may be required to pay the withholding taxes to CSC or make other provisions satisfactory to CSC for the payment of the withholding taxes as a condition to the exercise of stock options or the receipt of unrestricted stock pursuant to performance awards. Special rules will apply in cases where an employee pays the exercise or purchase price of an award, or the applicable withholding tax obligations, by delivering previously owned shares of CSC stock or by reducing the number of shares otherwise issuable pursuant to the award. Such a delivery of shares will in certain circumstances result in the recognition of income with respect to those shares.

Miscellaneous Tax Issues.  Awards to employees under the 2004 Plan may provide for accelerated vesting or payment in the event of a change in control of CSC. In that event, and depending upon the individual circumstances of the employee, certain amounts with respect to such awards may constitute “excess parachute payments” under the “golden parachute” provisions of the Internal Revenue Code. Pursuant to these provisions, a employee will be subject to a 20% excise tax on any “excess parachute payment” and CSC will be denied any deduction with respect to such payment. As described in “Performance-Based Awards” above, in certain instances CSC may be denied a compensation deduction for awards granted to certain CSC officers to the extent their aggregate compensation exceeds $1,000,000 in a given year.