Leidos Holdings Inc (LDOS) 2016 Q2 法說會逐字稿

Greetings and welcome to the Leidos second-quarter 2016 earnings results. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Kelly P. Hernandez, Vice President, Investor Relations. Thank you. Miss Hernandez, you may begin.

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our second-quarter 2016 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 July 1, 2016. Roger Krone will lead off the call with comments on the market environment and our Company strategies. 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 risk 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 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 second-quarter 2016 earnings conference call.

Our second-quarter performance was in line with our expectations. Revenue, profitability, and cash performed on or slightly above our expectations, which includes an expected below-average level of contract write-ups in the quarter.

Our end markets are gradually improving and, despite a slower pace of procurement activity from our customers for new awards, we are seeing increases in scope and the expansion in some of our existing contracts, all of this giving us increased confidence in our full-year outlook.

Since our last call, we've cleared a number of milestones related to the pending transaction to combine with Lockheed Martin's IS&GS business. At this time we have obtained all regulatory approvals, both domestically and internationally, and we have also filed our final registration statement with the SEC, which was declared effective on July 11.

Our integration management office is making significant progress in preparations for a transaction close date in mid-August. We have secured all required financing for the transaction.

Our debt facilities were well received and, based on strong demand, we were able to secure better economics as compared to when the deal was initially launched. These attractive rates now enable the transaction to be accretive in the first full year, as compared to our prior expectation of neutral accretion on a non-GAAP EPS basis.

We are encouraged by the recently reported results from IS&GS, as well as all of the feedback we are receiving from our customers, our employees, the IS&GS employees, and our shareholders regarding the positive impacts expected from this transaction.

In just a few days, on August 1, we will be hosting an Investor Day at the New York Stock Exchange to share further updates on the transaction, introduce new members of the combined management team, as well as provide financial updates related to the combined entity going forward. The investor event will be webcast live on our website at ir.leidos.com.

From a macro perspective, we are continuing to see a modest recovery in all of our end markets. The downturn has flattened out, and outlays are beginning to tick up. We expect that we will start the government fiscal year on October 1 with a continuing resolution, but that's been evident for some time now. What we don't know is how long that will be in effect, and this won't be finalized until Congress returns in September.

However, despite this, we expect a routine start to the new fiscal year, with levels of spending consistent with the budget request so that at this time we are not expecting much impact from the CR.

This year there's clearly a level of uncertainty surrounding the election and potential impact on budgets. However, we are certain that we are well positioned to capture an increasing share of the budget as we remain focused on solving our customers' most challenging mission-related problems.

On to the quarter:

Consolidated revenue of $1.3 billion was up 2.5% from the prior year, or up 9% when normalized for revenue from our heavy construction divesture, which closed during the quarter. We are encouraged by the growth in the quarter, particularly as it was driven by organic growth in both of our business segments.

We did have a couple of notables below the line this quarter, which offset each other -- one positive, related to lower taxes associated with updated accounting standards, and one negative, related to the strengthening of the US dollar against the pound sterling, driven by the British decision to leave the European Union. Jim will provide details on both of these in a few minutes.

Our GAAP earnings per share from continuing operations increased to $0.55 from $0.50, largely reflecting the impairment charges recognized in the prior-year period. Non-GAAP diluted earnings per share was $0.68 in the quarter compared to $0.77 in the prior year. The decline is driven by an expected lower level of profitability in our national security segment compared to the prior year, as I mentioned earlier.

During the quarter we generated $72 million in cash from operating activity, bringing our cash balance at the end of the quarter to $670 million. Our book to bill on a consolidated basis was 0.74 for the quarter and 0.84 on a year-to-date basis.

Bookings in the quarter were driven by strength in the health and infrastructure sector. We continued to experience stalled procurement activity with many of our government customers, causing delays in award decisions. I am pleased, however, with our team's ability to engage with customers against this backdrop and offer timely solutions to their mission challenges, which has resulted in scope expansions and program extensions helping offset some of the weakness from the broader delayed decision making.

Heading into the end of the government fiscal year, we do expect to encounter a strong quarter for bookings and awards activities, as is typical for the September ending period.

Overall, I am pleased with the quarter and the progress we are making in returning the Company to growth by focusing on our core competencies. Our priorities remain on our people, our capabilities, and our cost. And I firmly believe we are on the right track in all of these areas, not just in the quarter we reported, but in what lies ahead.

Before I turn the call over to Jim, I'd like to take a moment to recognize our employees for their hard work and dedication to the Company and to our customers.

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.

Our second-quarter results came in as expected, as Roger previewed, and we have increased confidence in our full-year guidance, which we are revising this morning.

Consolidated revenues for the first quarter were $1.3 billion, up 2.5% from prior-year levels. As Roger indicated, normalizing for the sale of our heavy construction engineering business, revenue showed organic growth of 9% from the prior-year period.

GAAP operating income was $75 million during the quarter, up 17% from the prior year's level, reflecting the impact of an impairment charge in the prior-year period, and partially offset by acquisition and integration costs incurred during the current period.

GAAP diluted earnings per share from continuing operations for the second quarter was $0.55 versus $0.50 in the prior-year period. Note that the divestiture of our heavy construction engineering business did not have any material impact on earnings per share in either period.

Adjusted EBITDA, which is based on our non-GAAP operating income, as detailed on slide 17, was $95 million during the quarter, representing a margin of 7.4%, down from $107 million, or 8.5% in the prior-year period. The lower level of adjusted EBITDA margin versus the prior-year period was driven by timing of indirect expenses as well as lower program fees and contract mix in our national security sector as compared to the prior-year period, offsetting improvements in our health and infrastructure sector.

As Roger previewed, we had two below-the-line items during the quarter which effectively netted each other out.

The first was a $0.04 positive impact driven by a lower GAAP tax rate during the quarter of 32% versus our normal tax rate of 37%. This lower tax rate was due to our early adoption of updated accounting standards related to accounting for share-based compensation. This change results in a lower tax rate, not just for the quarter but also retroactively to the first quarter, resulting in a $0.05 increase to our prior reported Q1 non-GAAP EPS results.

The second below-the-line impact was a $0.04 negative effect of currency translation adjustments related to an intercompany receivable. This is a nonoperating, noncash item which impacted the quarter and was the result of the significant movement in the value of the pound sterling versus the US dollar, driven by the Brexit referendum.

And, as I said, these two effects offset each other during the quarter.

Q2 non-GAAP diluted EPS from continuing operations was $0.68 per share, down from $0.77 in the prior year, as detailed on slides 15 and 17 of the investor presentation on our website. Note that non-GAAP diluted EPS for the quarter excludes acquisition and integration costs of $15 million associated with our pending transaction with IS&GS. Non-GAAP diluted EPS also excludes amortization of acquired intangibles and other items as detailed on slide 17 of the investor presentation.

Operating cash flow generated by continuing operations was largely in line with our expectations at $72 million, which reflects payments associated with the acquisition and integration costs previously mentioned.

We ended the quarter at 65 days sales outstanding, flat sequentially as expected, when normalized for the sale of the heavy construction engineering business.

We exited the quarter with a sizeable cash balance of $670 million and we are well positioned for the expected closing of the IS&GS transaction later this quarter.

Shifting to our business development results, the pace of bookings was impacted during the quarter by the delays in procurement activity at our government customers, as Roger indicated. However, in Q2 our business development teams experienced an uptick in RFP activity and we realized a significant sequential increase in bid submissions. Second-quarter net bookings were $951 million, reflecting a book to bill of 0.74.

During the quarter we made two adjustments to our backlog, a $177 million reduction to our international backlog to reflect the strengthening of the US dollar versus the pound sterling, as well as a $125 million reduction to remove the backlog associated with our heavy construction engineering business which was divested.

The value of bids outstanding at the end of the second quarter was $12.8 billion, up 8% sequentially, reflecting both a sequential increase in bids submitted in Q2, as well as the delays in awards in the quarter.

Let me now turn to our sector results for the second quarter.

First, in our national security solutions sector, or NSS, revenues increased 4% year over year to $915 million, driven by the ramp-up in our UK LCST program.

Operating income in NSS in the quarter declined from the year-ago period to $61 million, or 6.7% margin. The lower level of profitability is due to lower program fees and contract mix when compared to the prior-year period.

NSS bookings for the period were $520 million for a book to bill of 0.6 and 0.8 on a year-to-date basis. We anticipate a higher level of bookings in Q3 due to several anticipated award decisions as well as typical seasonality at the end of the government fiscal year.

Now, on to health and infrastructure, or HIS. HIS revenues for the second quarter were $373 million, a decline of 1.6% from the prior year. However, when normalized for the sale of the heavy construction engineering business, revenues in HIS grew 23% organically. This strong revenue growth was broad based, with improvements in the majority of our operations within the health and infrastructure sector, most notably within our defense health program.

Q2 operating margin for the sector was 10.5%, reflecting the strong contribution of our defense health program, as well as improvement in our commercial health operations.

Bookings for the quarter in HIS were $431 million, resulting in a book to bill of 1.2 for the quarter and 0.9 on a year-to-date basis. The strong book to bill is predominantly a result of contract awards and modifications, including the Hawaii Energy Efficiency Program and the Defense Health Agency's Genesis program.

Onto our corporate sector. We realized net expenses of $25 million during the quarter. This includes approximately $15 million of transaction and integration costs associated with the proposed transaction, which is 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.

Now, moving on to guidance, with half of the year behind us and the successful close of the sale of our heavy construction engineering business, we are now narrowing our 2016 revenue range to $5.1 billion to $5.2 billion, from $5.1 billion to $5.3 billion. Note that our initial revenue guidance issued at the beginning of the year, included approximately $200 million of revenue from the heavy construction engineering business. Only $100 million of this was realized prior to the closing of the sales transaction.

For non-GAAP diluted earnings per share we are increasing the range by $0.10, to $2.85 to $3.05, reflecting the impact of our first-half results from the lower tax rate detailed earlier, as well as our increased confidence in the full-year results.

We expect our tax rate, excluding any impact from our pending IS&GS transaction will be approximately 36% for the second half of the year.

Finally, for cash flow from operations, we continue to expect to be at or above $275 million.

And, as a reminder, all guidance metrics are provided on a basis to exclude any impact from the proposed transaction with IS&GS.

In conclusion, we are pleased with the momentum of our business and the strong organic growth in both of our segments. We remain resolutely focused on all aspects of the Leidos platform, including people, the capabilities, and costs, in order to address the needs of our customers and to grow our business.

Looking ahead, as we move towards a successful close of our transaction with IS&GS, we look forward to sharing more details regarding our view of the combined entity at our Analyst Day on August 1.

And with that, Operator, let's now open it up so that we can take some questions.

Thank you. At this we'll be conducting a question-and-answer session. (Operator Instructions) Cai von Rumohr; Cowen and Company.

So first, if you could walk us through -- the revenue guide came down. $100 million of that was the design-build sale. How much do you expect the impact of Brexit to be?

Cai, this is Jim. Right now we're --

The FX impact, obviously.

Sure. Right now we expect the impact of Brexit on revenue to be immaterial. There's a slight downward impact, but that's been offset by some other positive impacts elsewhere in the business which give us kind of a neutral view of those two items combined.

It's probably also worth saying that there will be no impact on the profitability of the program relative to Brexit because we have done a good job of matching the revenues and costs of that program to both being the UK currency.

Thank you. And so your margins at NSS of 6.7% I think were a little lower than some of us were expecting. Maybe walk us through some of the mix and lower fee issues and where you expect those to be for the year.

Sure. I think, as we've said before, we still think of this business, and expect this business, over the longer term -- not just intra-quarter but over the longer term -- to still be an 8% business. When we talk about contract mix -- I think we've said previously that the UK contract has a lower than average margin. And as that's ramped up it has put a bit of a dampening effect on our overall margin.

I think that there's a bigger impact, when you think of this year over year, Cai. And if you go back a year, the second quarter of last year had some pretty significant program write-ups that did not occur the second quarter of this year.

Now, with that said, we normally see some of those ticks that happen from award fees and EAC adjustments. They typically happen in the third and first quarter of the year. And so we're still thinking about the profitability of the division as a segment being pretty consistent with what we've said before.

Thank you. And the last one -- you saw some improvement in the commercial health and an uptick in security. Maybe update us or give us some color on how those businesses are doing and how they look for the second half.

Sure. In our last call I think we mentioned that we've made a few changes in management, both at the division management level -- that's working out very well for us. And we've also, back early in the year we brought in a new sales lead.

We have experienced a nice uptick in sales activity in commercial health. And there's also been some margin expansion there. So we're pleased with how things are going there. And the new leadership and new product offerings that we're incubating in that business we feel very good about.

And, Cai, this is Roger. Let me just add to Jim's comment is that by exiting businesses that are not in our long-term future -- Plainfield, the heavy design-build -- one of the great things about that is the management team now can refocus on those businesses that are part of our core. And Plainfield consumed a lot of calories for us and design-build as well. And now that those are behind us, the team has really been able to focus on the environmental business, the energy business, and the health business. And we're seeing a nice turnaround as a result.

Thank you very much.

Robert Spingam; Credit Suisse.

I wanted to ask a couple questions, starting with the organic growth in the health and infrastructure segment, what you had there.

Is that your question, Rob? I'm sorry; you're just asking a little more color on that?

Yes, a little more color on the organic performance there. I guess if you take the divestiture out I just wondered if there's anything else or if it's just a clean number, and what the underlying performance is there, Jim.

And then I also wanted to ask about the collections that you spoke of in the release a little bit, of timing on the working capital.

Sure. Let me start with the health and infrastructure group. Again, organic growth there 23%. We said it's broad-based, and that's a fact. The defense health business, the Genesis program, which used to be known as DHMSM, has actually experienced some nice -- some contract amendments on task order number 1. So the volume there is a little bit higher than we might have thought six months ago.

I would also tell you that the performance of the program is in line with expectations from a margin perspective.

And there's probably a tangible impact on the commercial health business from now we're conducting one of the largest, if not the largest, EHR implementation that there is with the defense health program. And that helps give us a little of an additional swagger in the commercial health business. And the margins are expanding there nicely as well.

I would say that the engineering part of the business is performing nicely, about on expectations. I think that really where we're seeing the biggest updraft in that segment is on both commercial and the US government health business.

To that point --

(Multiple speakers) -- yes, go ahead Rob.

Well, just as you're mentioning it, Jim, or Roger, when will that swagger begin to convert into some more opportunities or into some more contracts in either the commercial world or elsewhere in the government?

Well, Rob, I think they really already are. We've seen some expansion in the volume of the Genesis program. We are seeing a nice uptick in the commercial health business, as I mentioned. And this is also giving us I think some additional interest in the agencies, such as the VA, where we already have a presence and we can be looking at an expanded presence.

And when we have our Investor Day on August 1 we're going to talk I think a lot more about how our existing strength in both elements of our health business, combined with the qualifications that come over from IS&GS, in other elements of the health business, particularly at CMS, we're going to have a lot of conversations about what that means for the combined business.

Okay. And then I interrupted. You were trying to answer the question on the collections.

Yes, so if you go back to looking at our collection pattern, or I should say our seasonality on cash flow in 2015 and even back to 2014, you will see that there was a much more significant uptick in seasonality in cash flow in Q3 and Q4. You saw it last year. We're expecting to see it again this year, maybe not to the same -- I mean, if you look at our guidance number, we're not going to have the same influx of cash in the second half of this year like we saw last year. But we're still expecting it to have -- we're going to have a nice ratio of cash from operations to net income over 1.0x.

Okay. And then just lastly, Roger, what are you thinking in terms of book to bill for the two businesses for the year?

Slightly above 1.

In both cases.

Yes.

Okay, thank you.

Yes. No, I -- we've always been a bit seasonal, with third quarter being our strongest. And as we kind of look at our pipeline and our book to bill, that's what we're expecting this year as well. You know, obviously we want to continue to grow and so we're pushing the team for that number to be north of 1.

Okay. Thank you both.

And I'll just amplify on that with one additional point. We really did see a significant uptick in RFPs we were responding to with strong qualifications in Q2, Rob. And our win rates are holding up consistent with what our plan is. And so with additional volume and holding on to the win rates and the different elements of our bid pipeline, that underpins the confidence that you've heard from me and from Roger.

Okay. Thank you.

Bill Loomis; Stiefel.

A couple things. One, can you just fill us in on the UK contract, where you stand there with the transition and how we expect to see margins and profitability over the next year?

Let me talk a little about what's going on in the contact and then I'll have Jim touch on the numbers.

First, we were just there. We had our leadership team over in the UK last week. And we went to Doddington, which is near Telford, which is the big fulfillment center. It's kind of like the equivalent of the DOA here. And we looked at the legacy buildings, which is where the current fulfillment of commodity supply is done for the MOD. And we visited what they call the new Defence Fulfilment Centre. It's about a million-square-foot warehouse that we are building on behalf of the MOD. There's a roof and a floor and they're putting in roads. And we will put the first material in that new warehouse in December.

So that is essentially on track, given where we started the program really about a year ago. I think we actually had authority to proceed last August. So we're really pleased with the progress. We've already seen significant increases in efficiency and throughput. By the way, some things we care about, like lost workday case rates and accidents and things like that, are significantly down.

We've got a great relationship with the UK customer. I'm on the strategy board and we go over four times a year and we sit down with the three-star in MOD who's responsible for defense fulfillment. So so far, everything is on track and we will be moving material from their legacy warehouse complex to their new starting in December. And by this time next summer we should have the warehouse fully stocked. We'll have our new software installed. And we'll be driving efficiencies into the program.

Okay, with that, let me let Jim talk about where we are in the numbers.

Relative to the contract performance as Roger mentioned, Bill, the contract's performing well. Margin generation is as expected for the current phase of the contract, which has a fairly significant level of pass-through costs, which do not have -- because they are direct pass-throughs they do not have a markup on them. But we still have to book the revenue on it.

As the contract moves into the next phase and we're actually beginning to increase the volume of what we're buying on behalf of the customer, that's when the opportunities to earn some incentive fees relative to what we're saving for the customer, we're able to start to recognize those at higher levels, which we're expecting to really kick in more next year than they are this year.

And then the last thing that I would say is that our strategy for the bidding and standup of this contract is make decent margin on this contract and then look to expand our presence in this kind of work, not just in the UK but elsewhere. And so we're viewing this as being a great place to plant the flag for commodities and logistics services in that part of the world. And so far, this is a very referenceable customer. We're performing well and we're meeting our financial objectives.

Yes. I would just add to that very quickly, Jim and Bill, is in discussions we have with the UK customer, again, because I think of the performance that our team has demonstrated, they are contemplating could they add more classes of commodities to our contract. And we hope that that will eventually happen. We've actually told them we'd like to get the warehouse complete and get our new software installed and get our systems up and running. But we think there's opportunity in the relatively near term to add what we would call over in the US additional classes of spares to the contract, which would allow us to expand the top line and therefore the bottom line.

Okay, great, and just one final one. Jim, what was the ending rate and all the cost of financings for the transaction? What'd you end up with?

Right now the new financing is coming in at an average just a hair over 3%. So there's two things that have happened since we previewed the financing back in January. One, as we've negotiated the final financing we negotiated better credit spreads than we had originally modeled.

And then the second thing is that we had a conservative view of -- meaning a higher view -- of where the LIBOR base rate was going to be. And those upticks haven't happened.

And the last point that I would make is that we're now modeling and expecting to lock in a significant part of the new debt at a fixed rate using derivatives that are priced very attractively in the market today. So we're looking at a strategy that takes a lot of risk of up draft and floating rates out, but also takes advantage of a very favorable interest and swap market today.

Okay. So for us using -- including all the fee amortizations and other costs in there, we should model, what, like a 3.2 or 3.3 in our GAAP models?

Yes, for the incremental debt I would call it maybe about a 3.2, 3.1.

Great. Thank you.

Okay. And we'll have more to talk about that on the 1st of August, Bill.

Edward Caso; Wells Fargo Advisors.

It's from Wells Fargo Securities, actually. Can you talk about pricing in the market, particularly what the clients are doing regarding cost-plus, fixed-price, time and materials, how that shift is going? Are you seeing any residual hanging on to sort of low-price, technically-acceptable? Any thoughts on that front?

Ed, I think we've been saying for a couple of quarters that we have noticed the pendulum starting to swing away from LPTA. And I would comment I think we still see it swinging. But I would also point out that there are still some pockets of very, very aggressive lowest bidder cost shootouts that we see in the marketplace.

And we've said this before, whether it's a declared LPTA or it's a best value, price is always a factor in a procurement. And one of the reasons that we were so thrilled about the IS&GS merger is what we think it can do for us relative to reducing our wrap rates and being able to spread our corporate office costs over a larger direct labor base.

Because every customer we've got, they've got budget problems at their end, whether you're a hospital or you're an IC or you're an investor in a utility. And everybody has some sensitivity to price. We are seeing agencies that were almost exclusively LPTA having a better mix of LPTA and cost-plus and best value. But we think for the long haul, cost, price and affordability is going to be a major factor. So we're excited about the merger and the consolidation and what we think that we can do for what we call our wrap rates.

Can you remind us on the Genesis contract, is there a large pass-through component related to Cerner? And when does that kick in?

Yes. In the early stages of the contract, Ed, there are some license purchases. There are some equipment purchases. There is an element of additional work that our large software partner is going to have. And then later in the contract there's also some pass-through of subcontract work on change management and the actual training and implementation work done in the care facilities.

All of those are a part of the cost model on which [fee is borne]. So we're expecting a relatively consistent -- on this contract in particular -- a relatively consistent profit margin through the life of the contract.

And so, with that said, yes, there are some significant pass-through elements, different kind of pass-throughs, early in the contract compared to later in the contract. But a contract of this size you're going to need a lot of partners to do the different elements of the statement of work.

Last question: Can you just clarify for us on the net award activity in the quarter, the reported number and the constant currency number on a dollar basis?

Sure, Ed. The point of using constant currency is to ensure that we have visibility on the performance of bookings in today's dollars versus revenue in today's dollars. And to the extent that there is a booking in a prior year, the value of which has been impacted by changes in exchange rates, we isolate that. And that's the $177 million that I alluded to.

So as we're looking to show that the activity of today's awards are growing backlog, that's why we calculate book to bill on a constant currency basis excluding the upward or downward shifts in backlog because of currency issues.

Yes. And, Bill, I'm sure you realize that we have -- our program in the UK is a very long-term program and therefore it's a nice number in backlog. And any small change in the pound sterling has sort of a whipsaw effect. And we think it's important for you all to understand the effect of the movement in the pound sterling, which one might argue, over time is likely to go both up and down. And rather than try to explain how we lost $177 million in backlog due to performance, we want to make sure that there's strong visibility that that's a pound sterling backlog that's adjusted due to currency change.

Great. Thank you.

Tobey Sommer; SunTrust.

Along the same lines in the UK, I know it's early days but could you comment about Brexit in kind of the longer term opportunities in the UK to expand your business?

Yes, I think we can talk a little bit. Again, we were over in the UK last week and we met with customers and government officials and think tanks. By the way, I don't purport to be the expert on Brexit. What I did get a chance to do is to talk to a series of people who thought they were. And I think the first answer is I'm not sure anybody really understands what the long-term effect will be.

I think some trends that we walked away with is, there are going to be more borders than there were. And we're in the airport security, border security business, so we like that.

I think the relationship between the US and the UK is going to be one that continues to be strong. And I think that bodes well for us, by the way, in both ways. And our work in the UK is done with mostly UK nationals. We have very few expats. So we tend to take a couple of dozen people over and get a program started, but because of the type of work we do, very people driven, we hire the majority of our folks locally and do work in country. Don't think of us as an exporter. Think of us as a solution provider.

And so we are encouraged by the climate in the UK that we saw. They've got the same issues we have over here. They have defense health, national health issues, air traffic control, logistics. All the things that we have been successful here in the US we see the market in the UK being equally as robust. And, if anything, I think the playing field just becomes even more level.

There isn't necessarily a preference for you and so therefore it is one of the countries that in the new Leidos model that you will set off with a country leadership and country manager. And we expect to be there for the long term and we expect to see organic growth.

Thank you. I was wondering if you could give us a comment on your business in the cyber arena, with the US Cyber Command being particularly more publicly active. Thanks.

You know, we don't often say a whole lot. And I kind of like that posture. I think I'd like to say it this way, you can read in the press comments that are made by the President and by Mike Rogers and others about what they're doing. But then, I think if you understand the model of that agency, is they depend on a contractor base to provide a tremendous amount of support. And we like to support our customers and will bend over backwards to provide them the capabilities they need to do their job.

And so if you perceive there is a heightened level of activity coming out of those agencies, then that should be a positive development for all of the contractors who are supporting them on a day-to-day basis. It's part of our portfolio. I think it's a role that we're very proud of. And, frankly, we're very pleased that customers like that invite us to provide them people, analytical support, our products and services.

Was it additive to growth in the national security solutions segment?

Well, that's a precise question. I'm looking to Jim to say, okay, is that quarter over quarter, year over year? I think we would say it this way. It continues to be a strong part of our portfolio. And we expect it to continue to be a strong part of our portfolio over the long haul. And a specific number, I'll let Jim try to answer that one. I'm not sure I have quite that much insight.

Yes. I think, Tobey, it's safe to say that we do a very significant amount of cyber and cyber-related work for our customers. And the details around that I think they'd probably prefer we not get into too much of it.

I would tell you also that we consider that business to be very strong, very successful with plenty of historic and future growth ahead of it. And we're just not in the habit of commenting on individual contracts or individual operation results within the quarter. So I'll just leave it at that.

Okay. Last question for me: Could you comment on the opportunity at the VA and how you think that might develop over a mid to long term? Thanks.

Let me talk a little bit and then, Jim, you can add. We were added to the T4 IDIQ in the period, which is exciting. But I actually think that Lockheed had a T4 as well. So it's one of those where I think we both are going to have a T4.

Our Leidos business in the VA has been aspirational. The Lockheed business at the VA is more significant. And as much as I would love to be able to give you a complete soup-to-nuts rundown of the Lockheed business at the VA, it's a little premature for me to do that. But I know over the long haul Lockheed has been very, very successful in a couple aspects, one through an organization called QTC, through an organization they call Solutions Made Simple that they have [and] some of their base contracts.

And we're just looking forward to getting our defense, military, government health teams together and start to think about our strategy and our growth plans going forward.

Thank you very much.

Amit Singh; Jefferies.

Just quickly on the taxes, in the first half you got around $0.09 benefit from the tax adjustments. And now based on your new full-year tax rate assumption, what is the [PS] benefit in the second half versus what were you expecting before?

Yes, it'll be much smaller. So think of it as being a 1 percentage point downtick in our effective tax rate in the second half of the year, Amit.

Okay. All right. And then, on the top-line guidance, if you could talk about the guidance is lower, but when you did your first-quarter call at the end of April, was this divestiture already baked in at that point, or this is after that? And also, if you could talk about the EPS impact from the divesture.

Sure. What I would remind you is that at the beginning of the year our guidance included an assumption of $200 million of revenue for the design-build business that's been divested. And as you'll recall, we had a $5.1 billion to $5.3 billion revenue range at the beginning of the year. When we announced the divesture we did not at that time reduce our revenue guidance range because we felt that even after the divesture we were going to fall squarely in that band.

And now that the divestiture is done and we're half way through the year, we thought it was appropriate to narrow the range. And taking $100 million out of our model and then adding a few upticks on other areas allowed us to come squarely in at a new guidance number that we just announced of $5.1 billion to $5.2 billion. So I think that answers your question on the top line.

On the bottom line, the exclusion of that business, taking that out, has no impact on the prior-year or current-year EPS assumption because after absorption of indirect cost that business didn't have a material profit impact for us.

One thing I would remind you of, though, is that when you take the prior-year revenue out of the health and infrastructure business, our second-quarter growth rate, organic growth rate, for that business is about 23%.

All right, great. And just one last one. On the LCST and DHMSM contract, is there a way to tell us like how much of that contract is fixed price and what percent of the contract is sort of fixed price, cost plus. What is the sort of contract-type mix of those contracts?

Both of those contracts are pretty complex. And we're not in the habit of kind of getting into granular detail about that. But both of those contracts do have elements of fixed price, elements of cost type, elements of award fee. And I think that it is safe to say that those mix changes -- as I mentioned earlier in the call, the mix changes and scope and contract type on different elements of the tasks for the UK contract actually give us a little more profit margin and profit margin upside later in the contract. It should be relatively consistent on a margin basis over the life of the UK -- I'm sorry; the DHA Genesis contract.

All right. Great. Thank you very much.

Michael French; Drexel Hamilton.

Congratulations on the performance, and more importantly, securing the financing of the deal on favorable terms.

Roger, unfortunately I agree with you, it does look like we're going to be dealing with a CR for FY17. Very few legislate days left before the start of the fiscal year. And there's lots of work to be done by a distracted Congress. The question I have is, your comment that you don't expect much impact to the business, were you talking about Leidos or the combined Leidos and IS&GS? Or in other words, does IS&GS have exposure somewhere to the CR, whether it's new program starts or anything else?

Well, Michael, let me draw a very bright line. So after the deal closes I will be happy to talk to you about IS&GS. But until the deal closes, if you have interest in IS&GS I recommend you call Bruce Tanner and to Marillyn, because we just don't have that kind of insight into their business and I don't think it's appropriate for me to comment on Lockheed.

But on our business, what typically happens under a CR, procurement activity slows. We see contract extensions, additional task orders written on IDIQs. And that has two effects, which I thought we covered pretty well today, is our existing contracts are extended at their current terms, which often may be more favorable than what you see in the re-competes. However, the book to bill becomes a little tepid because instead of getting a two-year order, you get a two-month task order. And so where we had intended to see a new contract, we just see an extension and our book to bill comes down a little bit.

And I don't whether that's a little bit of what we saw in this quarter. And although we still, as we said before, expect to be above 1.0, an extended CR could slow down awards in the fourth quarter and first quarter of next year, depending upon how long it lasts.

But overall, the level of spending and the procurement activities that are in our pipeline, we don't see them overall negatively affected by a CR. Because, frankly, the world has gotten quite complicated. And we see that in the press every day. And as a result many of our customers are spending money as a result of, again, headline activity unfortunately that we all really read daily. So there's work to be done and they're finding ways to get contracts awarded and term contracts extended.

And so my comment was we don't see a long-term effect from the CR issue.

Thank you. At this time I will turn the floor back to Kelly Hernandez for closing remarks.

Thank you all for joining us on our earnings call today. We look forward to sharing more updates with you at our Investor Day on Monday, August 1. Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.