Kelly P. Hernandez - Leidos Holdings, Inc.

Roger A. Krone - Leidos Holdings, Inc.

James C. Reagan - Leidos Holdings, Inc.

Jonathan Raviv - Citigroup Global Markets, Inc. Edward S.

Caso - Wells Fargo Securities LLC Cai von Rumohr - Cowen & Co. LLC Tobey Sommer - SunTrust Robinson Humphrey, Inc.

Noah Poponak - Goldman Sachs & Co. Krishna Sinha - Vertical Research Partners LLC Brian Ruttenbur - Drexel Hamilton LLC

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our first quarter 2017 earnings conference call.

Joining me today are Roger Krone, our Chairman and CEO; and Jim Reagan, our Chief Financial Officer; and other members of the Leidos management team. Today, we will discuss our results for the quarter ending March 31, 2017.

Roger Krone will lead off the call with comments on the market environment and our company strategy. Jim will follow with a discussion of our financial performance and our expectations for the future.

After these remarks from Roger and Jim, we'll open the call for your questions. Today's discussion contains forward-looking statements based on the environment as we currently see it and, as such, does include risks and uncertainties.

Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. Finally, during the call, we will discuss GAAP and non-GAAP financial measures.

A reconciliation between the two is included in the press release that we issued this morning, and is also available in the presentation slides. The press release and presentation, as well as the supplementary financial information file are provided on the Investor Relations section of our website at ir.leidos.com.

With that, I'll turn the call over to Roger Krone.

Thank you, Kelly, and thank you all for joining us this morning for our first quarter 2017 earnings conference call. As the first full year of operations of the new Leidos post acquisition of IS&GS, this is a critical year in the company's journey to deliver competitively priced innovative solutions to a broader set of customers and to deliver value to our shareholders.

That being said, I'm really pleased with how the year has started off. Our first quarter performance exceeded our expectations on revenue, margins, and earnings per share.

During the quarter, we achieved the highest level of adjusted EBITDA margins for the company since our 2013 split and successfully turned IS&GS to growth. The diverse mix of our business, the focus on execution of both customer programs and the cost reduction initiatives enabled us to start the year with strong financial results and remain very confident in our full year guidance.

As Jim will detail for you later, during the quarter we also restructured our business segments along our end markets. And our new reportable segments are as follows.

The first is Defense Solutions, which represents about half of our business. This includes our Defense & Intelligence Group led by Tim Reardon and our Advanced Solutions Group led by Mike Chagnon.

Next is Civil led by Angie Heise which represents about a third of our business. Third, our Health segment, continue to be led by John Scholl, represents the remainder of our business.

And finally, we continue to report corporate expenses under the Corporate segment. The design of this segment structure is a reflection of our corporate culture focused always on our customers.

Throughout the acquisition and integration process, we've been very careful to avoid disrupting any of the strong working relationships that our employees have fostered with our customers. We have in fact augmented the breadth and depth of resources available to our customer facing employees to enable them to grow their relationships, while arming them with a very competitive cost structure and capability set which they can offer.

Our integration activities for the year are proceeding well and we're ahead of schedule to deliver on our previously stated synergy targets. Our general ledger consolidation which will drive a fair amount of our synergies is on track.

We've also restructured the combined businesses into integrated segments as I've highlighted earlier and further streamlined our organizational structure. These efforts resulted in several changes to the executive leadership team including, Dr.

John Fratamico, who is now Chief Technology Officer for the company. In this role, he oversees the offices of technology and engineering, which conduct research and development across all markets to unlock potential scientific discoveries or improvement in technologies for our customers.

Previously, John served as the President of the Advanced Solutions Group, where he led our specialists in some of the most advanced technical work for our customers. Mike Chagnon joined the executive leadership team as President of the Advanced Solutions Group, leading a team of over 2,500 scientists and engineers in the design and development of mission critical technical solutions across all of our end markets.

Throughout Mike's nearly 30 year career with Leidos, he has developed experience in systems and software engineering, specialized in the development and design of operational C4 enterprise systems for coalition, joint, strategic and tactical warfare of planning for CBRN/E effects assessment, decision support and mission planning. Sharon Watts now serves as our Chief Administration Officer, where she is responsible for managing the key central business functions and the optimization of indirect costs for the company and the integration and cost synergy achievement programs related to the IS&GS transaction.

Prior to this role, she served as Deputy President of the Defense and Intelligence Group at Leidos and previously as Vice President of Engineering and Technology for the IS&GS business at Lockheed Martin, where she led 16,000 professionals to provide a focused, strategic vision to the technical community on new business challenges, internal research and development, and growth initiatives. Our executive leadership team's depth of experience in the industry and diversity of background coming recently from both Leidos and IS&GS truly represents the world-class employees we had at Leidos, and I am confident will drive positive impacts for our employees and our customers.

As a testament to our team, our capabilities in our cost structure, we had several notable wins in the quarter – in cryptology for the Air Force, in cyber services for the Department of Homeland Security, and with the T4 Next Gen IDIQ for the VA. But probably most foretelling in the quarter was the large number of additional IDIQ vehicles we were awarded, which augment our large IDIQ portfolio even further.

We were awarded positions on 38 additional IDIQ vehicles in the quarter, with just the top five of those representing over $1.1 billion in expected revenue to Leidos. These wins expand our ability to address the Centers for Medicaid and Medicare Services, the Department of Homeland Security, the Defense Logistics Agency, among many others across our three end markets.

As is our practice, we do not book IDIQ wins into backlog until task orders are issued against them. As such, these important wins were not reflected in our book-to-bill number, which for the quarter was 0.7, reflecting net bookings of $1.7 billion.

While Q1 for us is a seasonally soft quarter for bookings, we were disappointed with several losses in the quarter, and we have initiated a thorough review of these bids. Additionally, we have seen more slowness than we expected in the acquisition organizations of our customers, due in part to the slow pace of executive leader appointments and budget uncertainty.

This has had two primary impacts, in our view. First is a delay in the procurement process.

Award decisions and procurement deadlines have been slipping to the right. Second, as a result of this, in many cases, the incumbent work related to those awards has been extended.

The combination of these has resulted in extensions to our current work, and these are generally shorter in duration and lower in magnitude than new awards, and have decreased backlog from what we expected. Our industry-leading scale, cost structure, talented people, and innovative capabilities are competitive differentiators, and by optimally leveraging these, we were able to win more work and drive up our growth rate.

We remain committed to solving our customers' most challenging problems, and continue to target a book-to-bill north of 1 for the full year. From a macro perspective, we're glad that Congress passed the full appropriations bills for both defense and domestic budgets for fiscal 2017.

Despite coming seven months into the fiscal year, we are optimistic that the passage of these bills should enable an increased level of decision making from the acquisition organizations. The agreement includes an increase in defense and OCO budgets and avoids the deep cuts that were proposed to domestic spending.

This backdrop bodes well for the market areas we are most exposed to and also bodes well, in our view, for what we can expect in fiscal 2018. We expect that government in fiscal 2018 will start under a continuing resolution, meaning that Defense Base and OCO will start fiscal 2018 at the fiscal 2017 rate, because we're coming off a full set of appropriations bills.

Additionally, as a result of the increased operational tempo in some of the world's hot spots, we have seen a slight pickup, in our in-theatre programs. Although not material, yet at a consolidated level, the trend appears to be sustainable in the near term.

The increased OCO levels agreed to by Congress also give us confidence in the sustainability of some of these recent pickups. In closing, I'm encouraged by our strong financial performance in the first quarter, the ongoing successful implementation of our synergy and integration plan, and the possible tailwinds from the policy actions of the new administration.

I am confident that we have the right team to capitalize on the opportunities in the market and the right capabilities to enable our customers to solve their most challenging problems. My team and I remain committed to focusing on growth, profitability and cash generation to deliver value to our customers and employees, and return capital to our shareholders.

With that, let me hand the call over to Jim Reagan, Leidos' Chief Financial Officer, for more details on the quarter and our outlook.

Thank you, Roger, and thanks, everyone, for joining us on the call today. We're off to a good start for the year, and as Roger previewed, we believe that we're on track to deliver to the guidance we provided in our last call.

Consolidated revenues for the first quarter were $2.6 billion, nearly double the prior year's level, reflecting the acquisition of IS&GS. On a constant currency basis, revenues were roughly flat organically when adjusting for the acquisition of IS&GS and the divestiture of our heavy construction business.

Also notable in the business is that after a long period of revenue declines within IS&GS, we were able to inflect to growth in the quarter, with revenues from legacy IS&GS up 1% on a year-over-year basis. We are pleased with this turnaround, and we believe that this reaffirms our thesis that with the acquisition, a lower cost structure, and more services aligned corporate structure would have positive impacts in the business.

The strength in all of our businesses this quarter helped us achieve our highest level of adjusted EBITDA margin since our split in 2013 at 10%, up 210 basis points from the prior year's level. Achieving our full year target early in the year is a great accomplishment, and reflects successful cost reduction actions, as well as strong program performance across all of our businesses, Civil, Health and Defense Solutions.

I'll discuss these more in a moment. Non-GAAP diluted EPS from continuing operations was $0.88 per share on a basis of 153 million shares outstanding in the first quarter.

Our non-GAAP diluted earnings per share primarily excludes the impact of $69 million of acquired intangibles amortization and $32 million of restructuring expenses and acquisition and integration costs. Operating cash flow during the quarter was lower than normal at a use of $88 million.

Two key factors drove our operating cash flow results in the quarter. First, Q1 has historically been seasonally softest due to onetime payments for employee bonuses and retirement contributions which impact the quarter.

Second, as we have previewed with you since we closed the transaction, the first half of the 2017 has always been planned to be a peak of contract novation activity during which we expect the temporary increase in our DSO levels as we work with customers to transition billing and payment processes to reflect the acquisition. We ended the quarter at 65-day sales outstanding, a 4-day increase year-over-year as a result of this activity.

We continue to expect an elevated level on the second quarter as well, but do expect a decline in DSOs in the second half of the year. We exited the quarter with a cash balance of $206 million after making another $20 million of debt repayments in the quarter.

As we said last quarter, we remain committed to our capital deployment philosophy, which balances a number of options to include investing for growth in the business, regular quarterly dividends, debt pay down, and share repurchases. Our balanced approach provides us with the flexibility to take advantage of market conditions to lower our cost of capital, while also driving increased value for our shareholders and an improved competitive position for the company long-term.

Let me turn now to our sector results for the first quarter. As Roger mentioned, we did restructure our reporting segments during the first quarter and we have provided a full year's worth of a historical results and pro forma results along the segment lines for you and the supplementary financials on our website.

First, in our Defense Solutions segment revenues of $1.3 billion grew 66% year-over-year, reflecting the acquisition of IS&GS. On an organic basis, revenues declined by 1.4% from the prior year as growth in our airborne programs was offset by reduced volume and the completion of certain other contracts.

Non-GAAP operating income for the segment of $95 million reflects a 7.3% margin. Operating performance in the quarter was strong, but impacted by reserve taken on one program which has required some course correction.

We are near closer on the issues here and we expect to return to a more normalized operating level in Q2. As Roger mentioned briefly, the macro environment has had an impact in this segment in particular where longer-term award decisions are being delayed and replaced in many cases with shorter-term extensions.

We do expect an improvement in the procurement climate when we have further budget clarity and executive appointments. In our Civil sector revenues grew more than 133% year-over-year, reflecting the IS&GS acquisition.

Excluding the contribution of the IS&GS acquisition in the quarter and the heavy construction business in the prior year period, which has since been divested, revenues declined 7% organically. Now roughly half of this decline was driven by currency fluctuations and the exchange rate between the U.K.

pound sterling and the U.S. dollar.

The balance was driven by declines in our commercial energy services business. There are a lot of moving parts here, but we're mainly encouraged by the success we're having in our Civil business most evident in our significant improvement in operating margin both sequentially and year-over-year.

Non-GAAP operating income of $88 million grew sequentially despite the decline in the top line. Non-GAAP operating margin of 10.5% is the high watermark in this business even when considering pro forma historicals.

As the segment with the highest level of fixed price work, this strong margin level is a reflection of the value of our ongoing cost reduction program with some added benefit in the quarter from some timing items that came in earlier than anticipated. Civil remains the area of our business where we get the most questions from investors regarding the impact of the proposed budgets and the administration's stated priorities.

We have conducted a thorough analysis of this business, both the legacy Leidos business and the IS&GS business, and we've determined that the policy positions indicated thus far should have a minimal impact given the areas in which we have exposure to civil budgets. The expected impact from any potential cuts to budgets at the State Department, the EPA, the Coast Guard, FEMA, and the Commerce Department are immaterial.

In fact, the appropriations bills agreed to last week did not include the $18 billion in proposed cuts for domestic spending which the administration had initially proposed, keeping the top level budgets flat for civil. Onto our health sector.

The Health sector performed very well in the quarter delivering both double-digit organic revenue growth and considerable margin expansion. Revenues for the sector came in at $443 million in the quarter, with non-GAAP operating income of $66 million, representing a 14.9% margin.

Revenue growth of a 159% year-over-year was driven by the acquisition of IS&GS, as well as organic growth of 11% due to the expansion in our Federal Health business. Non-GAAP margins grew 550 basis points from the prior year's level.

Even on a sequential basis, despite flat revenues non-GAAP margins grew 410 basis points. The drivers of this were really strong program performance across the board in the segment, as well as a favorable mix of programs and some timing items that benefited us in the quarter versus expectations of contribution later in the year.

While we would be cautious to expect this level of margin for the balance of the year due to the timing items I mentioned earlier, this margin expansion continues to validate our thesis that when run optimally with a strong focus on program execution, our Health business can provide a margin uplift to the broader organization. In our Corporate sector, we realized net expenses of $39 million during the quarter.

This includes approximately $19 million of acquisition and integration costs, and $13 million of restructuring expenses associated with the transaction, both of which are excluded from our non-GAAP results as stated earlier. Excluding these transaction related expenses, which we expect to incur for some time, Corporate sector expenses were within the typical quarterly range.

And now moving on to guidance. For 2017 revenue, we're reaffirming our prior guidance range for all metrics.

Clearly with our performance in the first quarter, we are very confident in the range, but recognize that it is still early in the year and there are numerous uncertainties ahead which we must continue to successfully navigate. Our expectations remain as follows.

Revenue $10.0 billion to $10.4 billion, adjusted EBITDA margin of 9.5% to 10%, and non-GAAP diluted EPS of $3.05 to $3.35. In conclusion, we are pleased with our performance thus far in the year.

We continue to optimize all aspects of the Leidos platform, including people, capabilities and cost in order to enable our employees to focus on addressing the needs of our customers and growing our business. With that, operator, let's open it up now so that we can take some questions.

Hey, good morning. Roger, I understand that in the slow award environment you can't really control.

But more on the unexpected losses, can you characterize what end markets those were, what's the postmortem, what are you doing to address and where and when you expect those losses to manifest, for instance, should we think about that driving us to the lower half of the sales guide for instance?

Yeah, okay, Jon. Thanks for the question.

At the time we closed the deal, there were about 150 bids outstanding between the two heritage companies. And they were bidding the heritage company's cost structure and with separate technical solution.

So, as we have moved into this new year, those awards are finally working their way through the acquisition process. And although we are actually quite pleased with how most of the proposals have done, there is a small number, count them on less – on one hand, that we were enthusiastic about winning and we didn't.

And I would say they were broken into half of those were the nature of our technical offering and half of those were where we were from a cost stand point. And realize this was a technical offering put together by the separate companies, so we didn't have the advantage of pulling our technical resources, and they were bid in the heritage cost structure.

And we've actually updated our rates twice since we put these proposals in, once on day one, and now we just updated our rates again here in 2017. That being said, no one ever likes to lose, and so we do as we always do, we call it (24:55) and we do an after-action review.

We go back and look at our competitive posturing, where we were in the pricing range versus where the awardee was, we take that, we go back, look at our cost structure to make sure that we are doing all the right things to continue to be competitive in the marketplace. In total, none of these were I would say material or significant, they are in – one is in the double digit millions, one – couple are in the three digit millions.

But in the scheme of our business development pipeline, like I said, at any given time we have 150 bids to 200 bids outstanding. We don't see it as material.

And again, we've reaffirmed our revenue guidance for the year and we think we're going to be just fine.

And just to clarify the double-digit and triple digit millions, that's not an annual run rate, that's over time?

That would be a face contract value.

Yeah, indeed. All right.

Thanks for thoroughness. I'll get back in the queue.

All right.

Hi. Good morning.

Could you – you mentioned a few times about pulling forward some performance. Could you sort of frame that for us, sort of how much was brought forward out of future quarters, and how much was just upside?

Yeah. Ed, we're – I wouldn't characterize that as a number of contracts, particularly as we saw rack up in the health business.

And when you think of these kind of pull forwards, typically there are EAC adjustments, and these are the kinds of things that are – I would call them ordinary course of business, they just were more phasing – time phasing items rather than things that we would say give us a reason to think that the margin that we have in – I am thinking of this, the health business is sustainable, so at the 14.9% rate. So we're pleased that those what we call pull forward items are there and again, they're more reflective of now that we're at a lower cost structure, we can update the longer term profit picture for a number of contracts and these were kind of updates to those EACs.

So think of them as write-offs.

Great. Other quick question, tax rate a little a little lower than we thought, is this the new accounting standard kicking in?

About half of it is the new accounting standard, Ed, and then the other half of it are permanent differences that we were able to pull in. There was a little bit of R&D tax credit there, but generally it's about – half of it is new accounting standard and half of it is real cash differences.

Thank you.

Thank you.

Yes. Thank you very much.

To maybe follow up on Jon's question. Roger, what was the annual run rate of the disappointing losses and what was the annual run rate, your expected annual run rate approximately of the 38 new IDIQ wins and did you have any bids that you won, but were protested and hence didn't make it into backlog?

Great question, Cai. Of course you know we don't do that.

So, relative to the run rate, I will tell you that two of the four bids were takeaways from other contractors where business was re-competed and we felt we were competitive enough – we're competitive enough to take the business away. I will tell you on the protest, sort of the business as usual today is there are always protests and there were some awards in the period that were protested.

Frankly there were some that we protested and there were some where the protest expired and we were eventually awarded the contract. And I think with all defense contractors and government contractors, we just see that as a fact of life today.

And then to the question on the 38 IDIQs, what's your expected run rate?

I'm not sure we have actually put it in that frame. We talked about $1 billion, plus a $1 billion task order generated from those, I mean that is typically is a couple of years – couple of hundred million dollars per year, maybe little bit higher than that.

Thank you. And then, Jim, you had a low tax rate in the quarter, did you adjust your tax rate for the year and if so, how come the earnings numbers didn't go up?

We haven't yet adjusted our expected tax rate for the year. We're – if we're going to make an update to the guidance, say, in the second quarter or third quarter, we'd probably take a second look at how we treat that in our guidance picture.

When we see the tax rate coming down a couple of points, it gave us about a $0.015 of tailwind on the EPS number which in the context of $0.88 non-GAAP, we didn't think it was that huge at this point.

Okay. And then last one.

In the Defense Solutions, you mentioned the charge on the fixed-price contract. Just for context, roughly how large was that charge?

And is that totally behind us?

Right now we think that the charge was certainly an adequate charge to take account for some increased costs that we had to make sure that we execute right for the customer involved. And so we're confident that it was more than adequate.

I would characterize it as a charge that's in the mid-teens in terms of millions of dollars.

Thank you.

Sure.

Thanks. Given generally better margin performance since the IS&GS acquisition and the expected, I guess, DSO relief in the back half of this year, do you look at the back half of this year as having increased financial flexibility with your debt level to start looking at repurchase and acquisitions a little bit more seriously?

Thank you.

Tobey, I think we've actually confirmed that view from the very beginning. And the performance that we have to date I think is going to allow us to do that.

And so of course there's always uncertainty, we're trying to figure out what's going in the government and it's early for us, but we always talked about looking at the back half and the cash generation and our capital allocation, capital deployment philosophy in finding the most efficient way to get that money back to our shareholders.

And the last follow-up from me is, how understaffed are the – your agency customers at this point, at the undersecretary kind of (33:06)?

I won't go agency by agency, but let's take the Department of Defense. So the Department of Defense has one confirmed person, and that would be the Secretary of Defense.

There are now identified candidates for some of the service secretaries and the Deputy Secretary of Defense, but now with healthcare sort of being the topic of the day, it's not clear when those will even get before the Senate. And we find other agencies in a similar position.

I'm not sure this is a precise number, but it's a number – over 500 confirmable administration appointments that have not been confirmed yet. So it's significant.

I was with another customer – I was with the NASA customer and of course they don't even have yet an identified NASA administrator. And so the civil servants, these are really great individuals, are doing the best they can to operate the government with the authorities that they have.

Okay. Thank you for the help.

Yeah.

Hey, good morning, everyone.

Hey, good morning.

Good morning, Noah.

Can you remind us what percentage of revenue comes from OCO, roughly?

Yeah, I think in the past, I mean a couple years ago, it was in the $200 million range. Now it's coming off that a little bit.

The thing that's always kind of the wildcard in that number, Noah, is that in the past two years the DoD has exercised perhaps more discretion on what comes out of the OCO budget than they have when that budgetary mechanism was first established. So I think that we're going to see that change again in the coming year, now that there's kind of a new budgetary regime in place that has a different way of working around the sequester limits, so.

Okay. When you were discussing Civil vis-à-vis the 2018 request that had DoD up a decent amount, but Civil sort of funding it.

I couldn't tell if you were saying that you were not as concerned as you hear investors are because the recent versions of bills we're seeing don't actually have those cuts going forward, or if you were saying that even if those cuts actually did occur, you just feel like you can navigate them with your positioning?

Well, let me start out with an incident – Jim can add to it – is if we look at whether it be the 2017 appropriations bill or the 2018 skinny budget against the civil agencies where we have a significant proportion of our revenue and then the departments of those agencies like Department of Transportation, where we have a lot of FAA work, we don't see even in the skinny budget significant cuts to the agencies that are our primary customers or the departments in those agencies that are our primary customers. And in fact, in some of our business like DHS, we see administration emphasis and priority, and increased spending.

And so that give us reasonable confidence – again, we don't have a 2018 budget – that we can maintain our top line in that sector. Jim, any – ?

Okay.

Yeah. Just in the world where there were going to be big cuts to certain agencies under the original, what they call the skinny budget, even then we didn't see material exposure.

Now that the skinny budget isn't skinny, we see even a more, I'd call more immaterial. As Roger indicated, the places where we're strong in Civil are places that are aligned to the administration's priorities, be it infrastructure work, working with the FAA, Centers for Medicare and Medicaid Services, Social Security Administration, et cetera.

That's interesting. And then just one more, just IS&GS being up 1% organically in the quarter.

It sounds like that was earlier than what you were thinking, even just last earnings call. Was there something pulled forward, or do you think that's actually sustainably in the black through the rest of the year?

There was some element of pull forward, but I think that what we were really thinking was that we weren't going to see a return to year-over-year growth until the middle of this year. So, it was a couple quarters earlier and that's encouraging.

I think the other thing that we like seeing, not just in the IS&GS part of the business but in the legacy Leidos part of the business, is stronger margins. And clearly, the thing that we're seeing now is stronger margins, strong program performance, because of the cost reduction actions that we've taken which you're going to see that more immediately in margins and fairly soon.

We expect to see it in win rates and more backlog building, because we're certainly able to bid on more competitive footing.

Terrific. Thank you.

Thank you, Noah.

Hi. Thanks for taking my call.

Just honing in on the Defense segment. Obviously you had a program specific or some program specific problems there.

Can you just describe to us whether the bid environment has changed in Defense where maybe there is you're seeing margin compression across the board, because you're not the only one that have talked about defense margins being down. And it seems like everybody has got company specific reason.

But I'm wondering if there is a broader trend here where you're seeing increased competition in that space. So can you just talk about that?

Yeah, what I would say, Krishna, is there is absolutely, I mean everyone in our business has to think of the environment remaining very cost conscious and cost competitive. With that said, we're pleased that aside from the one program where we did have to take a charge in the quarter, the business is running really well with strong margins and strong performance in the business.

So, I think that – if you rewind a few years, when there was a wave of really competitive pricing pressure that started or intensified, I would say, our industry I think responded across the board with being very, very cost conscious and cost aggressive. And I think that – the scale of our business now that we've – we're incorporating and integrating the IS&GS business, it affords us the ability to be as competitive as anybody from a cost standpoint, and at the same time, remain anchored around our target margin percentages.

Okay. And then on – IS&GS was up 1% organically, but it looks like Defense was down organically, Civil was down organically.

I understand part of that was from currency and some other things. But you said commercial energy services was down.

Can you just give us the moving parts on what drove that IS&GS coming up and what does that imply about the core Leidos business, so the pre-IS&GS business? Can you just talk about what you're seeing on that side of the business as opposed to IS&GS, which is up?

Yeah. There were a lot of embedded questions.

I'm going try to zero in on what I think you are focusing on and that is the – if IS&GS is up a point, what's going on in the legacy Leidos business. And what I would tell you, it's kind of a tough compare in Q1 because a year ago we had strong growth in the Leidos business, primarily on the backs of the U.K.

program which was ramping up substantially, as well as the DHMSM, the defense health agency program that was ramping up then. Part of that ramp-up a year ago was in a construction portion of the U.K.

program that is now completed. And so there is a dampening effect on the legacy Leidos growth from that, and then there is also where we have a big development push that we were under a year ago in DHMSM that we're not undergoing right now.

And right now we are in the testing phase on DHMSM and next year we'll see another big ramp up on that program as we begin the broad rollout across the Defense Health facilities.

Okay. And then, just one quick one on cash.

You talked about elevated DSOs in the first half. But how are you guys trending on your cash restructuring expenses year-to-date and do you see anything unexpected that's coming up here or nothing, something that might not be in the plan that you took charges on or is everything trending kind of exactly how you thought it was going to?

Right now, everything is trending exactly where we were expecting and the – as I think we alluded in the call, we're actually ahead of our expected realization of cost reductions. We're pleased with how that's going.

And normally, when I see better cost takeout than we had planned, I would've expected more restructuring and severance type expenses, which we haven't been seeing. So, so far the return on the restructuring expenses, I'm feeling, is a little higher than we expected.

That's great. Thank you.

Okay.

Yes. A couple of quick housekeeping.

First of all on your guidance in 2017, I didn't catch it. Did you anticipate then a government fiscal 2018 budget to be passed on time, or are you assuming a CR?

What is in that guidance?

Yeah, we assume a CR probably at least for calendar year 2017. So as you know there's a quarter mismatch between the government fiscal year and our year.

But despite the President's comments, and we're hopeful that he's right, but history has taught us to expect a CR.

Okay. And then just two other little follow-ups.

Integration, are you 50% integrated in your opinion on IS&GS, and that integration will be complete by the end of calendar 2017? Or when do you consider it done and put a tombstone in it?

Yeah, it's a great comment. We're engineers and program managers; we actually have a metric.

And we actually hit a 50% internal metric on 1 July, just so you know. But we really accelerate the back end of integration, and we expect to be in the 90% done by the end of first quarter of 2018.

So – and that program has really gone well. And now Sharon Watts, our new CAO, has commanded that.

And again we've been pleased at how smoothly the integration has gone.

Okay. And then final housekeeping, which is just tax rate levels, 31.5% in the first quarter.

I know there are some one-time items in there. Is that what we should be looking for going forward, that level?

Yeah. What we had said previously that the effective tax rate on a non-GAAP basis would be around 37%, and the thing that will drop that a little bit and that has dropped it a little bit is primarily the impact of the new accounting standard for taxes.

And so as our stock price goes up, it gives us a book tax deduction, if you will, that puts downward pressure on the rate. So given where the stock price is today, if it continues in that trend, you're going to continue to see some downward pressure on the rate.

But right now we're not quite ready to give you an updated full year tax rate, again for the full year.

Okay. Thank you very much.

Thank you.

Thank you.

Hey, guys. Thanks for taking the follow-up.

Sure, Jon.

Roger, you commented that 1Q beat your expectations on a number of fronts. Is it just a lack of budget certainty that's keeping you from increasing guidance, or should we think about this as more of a philosophical approach where you kind of want to wait until July or even October before adjusting your outlook?

Well, and Jon, we've been doing this a long time, and we just – if you think about it, we put out guidance with our year-end close, and here we are in first quarter. And philosophically we like to see more performance.

If there was a big non-recurring that moved the numbers up, we would just pass that off in guidance, but typically we want to see a little bit more demonstrated performance, a little bit more run rate. But of course, as both Jim and I said, we're really pleased with the numbers that we've seen, and frankly a little bit ahead on some of the cost reductions and the restructuring, and revenue has held up well.

Although I mentioned the competitive environment and some disappointments, we've also had great growth in our existing contracts, and our team has been able to expand some of our statement of work with some of the administration's priorities that can be covered by current contracts. So, again, we feel really good about the year.

But it's the first quarter. And for us, without something really compelling, we want to get more demonstrated performance, better understand the budget, what's going on inside the Beltway.

And then briefly, Jim, can you just remind us, versus your guidance of at least $475 million of operating cash flow this year, what's the assumed CapEx? And then also what is the – what is the full-year impact of that increased working capital cushion related to innovation?

Okay. So think of our expectation for CapEx at around $60 million, which would be – remember the $475 million is guidance for what is cash flow from operations on the cash flow statement.

So you got about $60 million there out of that on CapEx, and then the way we have thought about- what we've said previously the way we think about working capital assumption is about a three day increase from the end of last year to the end of this year embedded in that number, three day increase in DSO.

Okay.

Hey, just actually a follow up to that. What's the approximate millions of dollars in cash from ops related to a day?

I think it's $30 million a day.

$30 million. And then, beyond the novation reversal and the change in cash restructuring, is there anything else below segment revenue and EBIT that is a material change 2018 versus 2017 cash flow?

What we – we talked about CapEx is a little higher, obviously, because we're bigger that – that's $60 million that actually shows up in investing activities part of the cash flow statement, three days of DSO, and then we've also talked about the restructuring costs that show up in the P&L and their cash. So – and that will tail off early next year from a run rate basis.

Got it. And sorry, just a clarification on the CapEx comment.

You're saying $60 million is higher because you're a larger- or your run rate something more than $60 million going forward?

Well, yeah. Before the acquisition of IS&GS we were running about $40 million a year.

So, we're getting some great efficiency on a per revenue dollar basis with lower CapEx or a broader portfolio.

So something in the vicinity of $60 million is a good number to use for some period of time?

Yeah, that's right because – and the way we're getting that efficiency is much more effective real estate footprint. We're able to grow into some vacant space, as opposed to go out and procure new space and have resold improvements, et cetera on that.

And then one more, back to the order front. With everything you know, even recognizing that a decent amount of what you know is the degree of uncertainty in some ways, but I guess with everything you know, are you able to articulate a view on how orders trend as we move through the year or where book-to-bill shakes out for the year?

Well, no, I – in my prepared remarks we committed to book-to-bill greater than 1, which is where we've been for the full year. We've always been sort of a seasonal with the third quarter being our strongest with the appropriations bill, assuming it gets passed by the Senate today and signed by the President tonight, that will accelerate awards and I think we will see maybe even more seasonality into second and third quarter than we might have seen in prior years.

And as we kind of plot through the bids outstanding, and think about what's happening in customer space, I think it confirms that we will see maybe a little bit more seasonality this year, which means probably our peek awards quarter will be third quarter.

Thank you.

Thank you, Noah.

Hi, guys. I just want to make sure I'm understanding this correctly.

It sounds like -you guys have previously talked about a 3% revenue growth going forward, it sounds like a significant portion of that is driven by contracts that you already have booked, specifically some of your Health contracts. Can you talk about, maybe break it down in terms of how much of that 3% is going to be dependent on new awards that you book, so sort of the second half surge in bookings that you're expecting, and how much of that is just driven by what you already have that's embedded in your contracts?

Gosh! When we've talked about 3% growth, we've talked about that as being more in the 2018 and beyond as we begin to realize some revenue synergies that we talked about back in August.

These were things that as two standalone businesses neither company would have event bothered bidding, but now we can because of cost structure competitiveness and a broader array of capabilities to bring to our customer set. So, already at the beginning of the any given year, and this year was no exception, we already had visibility in the 80% of our work which was in backlog or high probability of win extensions of contracts.

So, you have a go-get. And right now with where we stand on contract growth as well as the awards we have today, that again gives us the kind of condolence that Roger and I talked about relative to our guidance.

So, I mean I would think about if you're asking to get to the 3% is that going to be more realized in things that still have to awarded and the kind of revenue synergies we've talked about, I think the answer is yes.

Okay. Great.

Thank you.

Great. Thank you, Rob, and thank you all for your interest in Leidos and for your time this morning.

Have a great day.