Leidos Holdings Inc (LDOS) 2017 Q2 法說會逐字稿

Greetings, and welcome to Leidos Second Quarter Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Kelly Freeman, Director of Investor Relations. Please go ahead, Ms. Freeman.

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our second quarter 2017 Earnings Conference Call. Joining me today are Roger Krone, our Chairman and CEO; Jim Reagan, our Chief Financial Officer; and other members of the Leidos management team. Today, we'll discuss our results for the quarter ending June 30, 2017. Roger 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 2 is provided 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 a 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 good morning. Kelly Freeman is the newest addition to our Investor Relations team and brings 17 years of experience in the Finance departments with Lockheed Martin and Leidos. We're pleased to have her here as our Director of Investor Relations. Thank you all for joining us this morning for our second quarter 2017 Earnings Conference Call. We had a very strong second quarter, driven by solid operational execution across all of our businesses. I want to thank our team for their unwavering focus on delivering for our customers and our shareholders. The results from the quarter and the year-to-date demonstrate our ability to extract even more value from the transaction than we had anticipated. And allow us to increase our 2017 guidance as well as our expectations of gross cost synergies from the transaction.

As we approach the 1-year mark since the closing of the IS&GS acquisition, I want to take a few minutes to reflect on all that we have achieved. We have fully incorporated 15,000 new employees into the company. Restructured the combined businesses into integrated segments along our end markets, and continue to add depth and strength to our leadership team. We have been able to outperform to the targets provided at our August 1, 2016, Investor Day. Specifically, we've increased our initial revenue guidance provided then by more than $200 million at the midpoint. And as I alluded to, and Jim will detail further, we are, again, increasing our non-GAAP diluted earnings per share expectations for 2017 to a revised range of $3.45 to $3.70, more than $0.30 higher at the midpoint from our prior range and nearly $0.50 higher than the initial expectations provided at our Analyst Day.

In addition, after raising our initial gross synergy estimates from $240 million in our January announcement to $350 million in our August Analyst Day, the focus and results we've seen to date allow us to once again increase our view here to now more than $400 million of gross cost synergies. Jim will provide more details on the integration activities and revised expectations shortly.

Overall, the past year has been one of transformational change and a lot of hard work by our employees. One notable effect of this transformation was our renewed inclusion in the Fortune 500 listing after having been excluded from this list following the 2013 split. This is a testament to the successful execution of the transaction, and most importantly, an external recognition of the efforts of our employees. Their commitment to customer and to a successful integration has enabled us to outperform expectations on many metrics and position us well for continued success and growth.

Now on to the quarter. Revenue for the quarter was $2.6 billion, and non-GAAP diluted earnings per share came in well above our expectations at $1.04. These strong results were driven by robust program performance and the immediate impacts of cost reductions across our fixed price and T&M programs. Adjusted EBITDA margins for the quarter of 10.9% exceeded both our full year and long-term targets due to these factors. Also, as expected, cash generation improved in the quarter, resulting in $177 million of cash flow from operations. We exited the quarter with $262 million of cash on hand and a consistent philosophy on capital deployment.

As we have said in the past, we consider a number of options for capital deployment to include investing for growth in the business, regular quarterly dividends, debt paydown and share repurchases. Our balanced approach provides us with a 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. Following a seasonally soft first quarter on awards, we saw a nice uptick in Q2.

Net bookings of $2.7 billion in the quarter drove a book-to-bill of 1.0. We are pleased with the numbers here, although, we continue to focus on driving improvements in our business development operations. We continue to focus on building a healthy, qualified pipeline and increasing the win rates of submitted proposals through 3 primarily competitive differentiators. First, competitive pricing, which we have enabled through cost synergies. Second, innovative technical solutions, which we continue to strengthen through investment in both people and capabilities. And third, our deep customer relationships.

A few notable program wins in the quarter possible through success in these 3 factors include: a recompete contract with the Veterans Benefits Administration supported by our health group. This contract allows us to continue our decade's long commitment to serving the nation's veterans with critical clinical support. This win was held up in a protest for nearly a year, and after recent resolution, contributed to our bookings in the quarter. Another win is a task order awarded by the U.S. Army to provide program management solutions to the Department of Defense Biometrics program. This win marks an example of a true revenue synergy as we were able to leverage legacy IS&GS's prime position on the DoD Automated Biometrics Identification System vehicle and our extensive combined qualifications in tactical biometrics collection, processing, and solution development.

Finally, in our defense segment, we were awarded a third task order by the U.S. Army to lead the integration of Airborne Reconnaissance Low-Enhanced systems, the ARL-E program, as we call it, as we have noted before is a program of record supported by our Advanced Solutions Group, enabling a multi-intelligent airborne platform that provides a persistent capability to detect and track targets with a high degree of timeliness and accuracy. From a macro perspective, we've seen a couple notable improvements since last quarter. First, the May agreement on the fiscal '17 budget provided clarity on spending levels through the end of September.

And secondly, we saw further progress in the resolution of key presidential appointments, including the confirmations this week of several important leadership positions at the Department of Defense. However, despite this progress, the still high number of unfilled leadership appointments and the approaching government fiscal year-end continue to serve as headwinds, in our view, to a more normalized procurement and acquisition pace with our customers.

Organizationally, during the quarter, we continued to strengthen our company leadership through the addition of Frank Kendall, former Under Secretary of Defense for Acquisition, Technology and Logistics to our Board of Directors. Frank brings over 40 years of experience in national security affairs, acquisition, engineering and the military, further improving our board's breadth and depth of experience. In addition, recently, after 7 years of service to the company, leading a world class legal team, our Executive Vice President and General Counsel, Vince Maffeo, has decided to retire.

I want to thank Vince, not only for his contributions and leadership in helping navigate the company through several pivotal milestones, including the separation from SAIC and the recent acquisition of IS&GS, but also for his guidance, advice and support over the past few years that I have been with the company. Replacing Vince will be Jerry Howe, who comes to us most recently from Fried, Frank, where he served as partner. Jerry brings more than 30 years of leadership experience at global organizations in aerospace, defense and intelligence.

Jerry's demonstrated background representing clients and government contracts litigation, investigations and bid protests as well as M&A will serve us well and I am excited to welcome him to the team. In closing, I'm pleased with our strong financial performance in the second quarter and in the first half of the year. While there continue to be challenges ahead in this uncertain and competitive environment, I remain encouraged by the strength and determination of our employees. Their demonstrated ability to focus, not only on delivering innovative solutions to our customers, but also on successfully implementing integration activities critical to enabling an optimum cost structure, gives me confidence in our ability to succeed, grow and create value for 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 full year outlook.

Thank you, Roger, and thanks to everyone for joining us on the call today. Our second quarter results reflect improved bookings and operational momentum across the board, and allow us to increase our expectations for the full year. Consolidated revenues for the second quarter were $2.6 billion, double the prior year's level. This reflects 6% organic growth in the IS&GS Business relative to pro forma historicals, offset by a comparable decline in the legacy Leidos business. GAAP operating income was $166 million during the quarter.

Non-GAAP operating income in the quarter of $264 million, excludes the impact of $98 million of adjustments, including most notably, $67 million of acquired intangibles amortization and $22 million of restructuring expenses and acquisition and integration costs. Adjusted EBITDA margin, which is based on non-GAAP operating income was above our expectations at 10.9%. This strong performance was the result of our disciplined focus on cost reduction actions as well as strong program performance across all of our businesses. Margins in the quarter benefited from 2 notable items, which we don't expect to recur in future periods.

First, due to delays in acquisition cycles and protests of awards, we benefited from extensions of key higher-margin programs. As the final award decisions on these protested recompetes took longer than expected our first half results benefited from a slower than expected ramp down of these programs. Now that these protests have been resolved, we expect to transition to a lower level of revenue and profit from these programs beginning in the third quarter.

Second, we also benefited from an elevated level of program write-ups in the second quarter, reflecting outperformance in our cost reduction activities relative to our expectations. Non-GAAP diluted EPS from continuing operations was $1.04 per share on a basis of 153 million shares outstanding in the quarter. These strong results were driven by the higher level of adjusted EBITDA margins, coupled with a lower tax rate. The non-GAAP effective tax rate for the quarter of 32% was below our previous estimate of 37% and drove an $0.08 benefit to earnings per share. The lower-than-expected tax rate was due to higher than forecasted tax benefits from equity compensation awards.

Operating cash flow increased sequentially as expected, resulting in a generation of $177 million during the quarter. This was driven by an improvement in our billings and collections processes relative to last quarter, as we continued to work through contract novation related items resulting from the IS&GS transaction. DSOs ended the quarter at 65 days, flat sequentially. We continue to expect DSO reduction from our Q2 levels with a year-end target of approximately 63 days. This estimate embeds a buffer for potential short-term disruption of cash billing and collection cycles driven by the timing of integration activities. We ended the quarter with a cash balance of $262 million after making another $46 million of debt repayments in the third quarter.

Before I move on to segment results, I'd like to provide some further detail on 3 key integration milestones. First, on July 1, we successfully transitioned the human resource and payroll management system used by a majority of the IS&GS employee base on to the Workday solution used by legacy Leidos. Second, we streamlined all purchasing activity onto a consolidated procurement system, converting over 10,000 legacy IS&GS purchase orders in the process.

Third, we began the process of migrating financial systems, completing the transfer of a portion of the IS&GS Business over to the Leidos Cross-Point solution. This successful transition gives us confidence and experience as we look ahead to the single most important integration activity still ahead of us. And that's the consolidation of the remaining financial systems, which is slated for Q1 of 2018. The successful completion of these actions keeps us on our integration schedule and has significantly reduced our dependencies on Lockheed Martin transition support. We anticipate realizing additional cost savings as we exit the transition services agreement ahead of schedule in the third quarter. At the halfway point in the year, we have already achieved our full year 2017 run rate targeted cost synergies. And we're now updating our gross cost synergies target to over $400 million of annually recurring savings by 2019, up from our prior target of $350 million.

In order to capture this additional $50 million of annualized cost synergies, we expect to incur additional cost, and thus in tandem with the higher cost synergies target, we're revising our integration cost expectation to roughly $275 million from our prior expectation of $235 million. We believe this additional expense generates a high return on investment and we're confident in our ability to drive these additional savings just as we have delivered on the targets thus far.

Let me turn now to our segment results for the second quarter. First, in our Defense Solutions segment, revenue for the quarter was $1.2 billion. Organically, revenue declined about 1% year-over-year, reflecting program completions, partially offset by increased volume in our airborne programs. Non-GAAP operating income for this segment was $109 million. This reflects an 8.8% margin for the quarter, a sequential improvement of over 150 basis points, representing a return to more normalized program performance in this segment.

In our Civil segment, revenue for the quarter of $875 million reflects organic decline in the legacy Leidos business compared to the prior year and the integration of the IS&GS Business revenues. The organic decline is due to the ramp down of the LCST fulfillment center build-out recognized in the prior year period as well as scope reductions in some existing programs. Non-GAAP operating income of $96 million for the Civil segment grew sequentially. Non-GAAP operating margin of 11% set a new high watermark for this business relative to the pro forma historicals, reflecting strong program performance and a lower level of indirect costs as discussed earlier.

Now on to the Health segment.

We had a second consecutive quarter of strong performance, which contributed to margin lift at the consolidated level. Strong revenue for this segment of $454 million was driven by program extensions and increased scope on some programs with our Federal Health customers, offset by the timing of revenues in our commercial health practice. Non-GAAP operating income of $74 million in the quarter represents a 16.3% margin, up 740 basis points from the prior year's level. Notably, non-GAAP margins also grew 140 basis points sequentially. The continued strong performance of our health business relative to our prior expectations was driven by strong performance on contracts referenced earlier, which benefited from unanticipated extensions of work, while protested recompete award decisions were in process.

Final award decisions were made in the second quarter, which, combined with additional wins, drove our outsized book-to-bill in this segment at 2.2x for the quarter. Now that the protests have been resolved, we expect second half revenue -- the second half revenue run rate and profitability level for our health business to be at a more normalized lower-level as the extension work which buoyed first half results winds down. On to our Corporate segment. We incurred net expenses of $37 million during the quarter. This includes approximately $16 million of acquisition and integration costs and $6 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 segment expenses were within the typical quarterly range.

Now moving on to guidance. Our strong first half performance gives us more confidence in our expectations for the full year. And while there is the possibility of a government shutdown at the start of government fiscal year '18, our guidance continues to embed an assumption that the year begins with a continuing resolution. Our updated guidance is as follows: Revenue of $10.1 billion to $10.4 billion tightening up our prior range of $10.0 billion to $10.4 billion. We now expect adjusted EBITDA margins of 9.8% to 10.2%, up from our prior range of 9.5% to 10%. We expect non-GAAP diluted EPS in the range of $3.45 to $3.60 up from the prior range of $3.05 to $3.35. Our guidance for cash flow from operations is unchanged at or above $475 million, reflecting the potential cash impact of planned system migrations which are scheduled to commence at the end of Q4.

In addition, we now expect our full year non-GAAP effective tax rate to be in the range of 35% to 35.5% versus prior estimates of 37%. In conclusion, we are pleased with the momentum in our business and we're encouraged by the opportunities ahead of us. We remain focused on achieving our targets and driving synergies across the combined business to create value for our shareholders. And with that, Rob, let's now open it up, so that we can take some questions.

(Operator Instructions) Our first question is coming from the line of Jon Raviv with Citigroup.

Can you talk a little bit about to what extent the higher synergy target goes to the bottom line. And then I know you're not going to talk about 2018 at this point. But if you're exceeding your 10% EBITDA -- if you're potentially exceeding your 10% EBITDA target this year, is there a chance to do better in '18 or should we be mindful of some of the programs that are running hot this year that won't necessarily repeat next?

Sure Jon, and thanks for your question. So what we've previously said is that approximately 1/2 of cost savings drops to the bottom line given that about half of our business relates to cost type contracts. What we've also said is that you can expect the piece that is not savings that is attributable back to the customer to go to enhance margins, but also gives us the capability to reinvest in the business, whether it's in additional market development and business development activities or research and development type activities. So I think that now we're seeing the possibility of EBITDA margins that are above the 10% that we had previously said. Our target was -- and you are right, we're not yet ready to talk about what margins will look like in 2018. But certainly, the success of our integration and synergies gives us the capability to be more confident in margin increases, but also give us the possibility of going in and investing more in the things that drive future growth in our business.

And then in the quarter and year-to-date, we've seen a little bit of diversion performance between legacy Leidos and legacy IS&GS, especially, on the sales side. How do you think about those 2, I know you're not going to guide specifically to those. But what's going on year-to-date, what has to happen in each of those items going forward as you look to achieve 3% organic growth in '18 and beyond?

First, John, I would tell you that the growth in IS&GS Business, we're really pleased with. And in fact, that part of the business has grown a bit faster and performed a bit better on the top line than we had originally modeled. With that said, the compare from last year on the legacy Leidos business, it's really a couple of things. One, as you might recall, we had a big build-out portion of the LCST program that gave us some unusually strong revenue in the Defense segment a year ago, that did not recur this year. The margin on that revenue was very modest. I think the second piece of it, you would think about as being some defense programs that wound down relative to last year. But remember that when we talk about how we're growing the business and how we're investing, we're thinking about this more, certainly, on a more consolidated level.

And then just to pass the 3% next year, what has to happen from your judgment?

The coming quarter for book-to-bill is always our seasonally best quarter. And achieving our own expectations on both the book-to-bill in Q3 and in Q4 as well as some of the revenue synergies that we've talked about at Analyst Day. I think that one of the wins that we just saw in the past quarter, is kind of emblematic of what we were expecting in terms of higher PWIN on certain efforts that combine both the depth of the technical capability of Leidos, particularly, in biometrics, along with deeper customer relationships that the combined business gives us. That's how we got to thinking about a target of 3% for next year.

Our next question comes from the line of Noah Poponak with Goldman Sachs.

Jim, when you say Health back half should have more normalized revenue and margin, can you quantify that? Because hear you on why the margin was a little hot in the quarter, but it's been pretty close to the level that was at in the quarter, 3 quarters in a row now. And similarly, on the revenue, it's sort of been in this same place sequentially 3 or 4 quarters in a row?

As you know, Noah, we don't guide to margins -- that is segment specific results on revenue and margin. But what I would tell you is that the performance on a handful of contracts that, while those contracts aren't going away, the revenue run rate on those is going to go down a bit. And the contract extensions are priced at a level that would imply that the margins are going to come down, although, we're still looking at strong margins for that part of the business going forward. But does not, as we said during the prepared remarks, the 16.3% is not something that we expect to go into the second half.

Can you quantify how much revenue you lose sequentially from those contracts?

Noah that would give -- that would kind of violate our policy of not guiding to segment specific numbers for the year. So I think, we'll have to wave off on that one.

Okay. Fair enough. The LCST build-out. When do you annualize that, such that it's no longer a year-over-year headwind?

That should be around the end of the year.

Next year.

Yes...

So that's sort of a growth headwind 3Q, 4Q and then ceases to be one as you start '18?

That's right.

Yes.

Okay. And then just finally, how should we think about where 2018 cash flow from operations goes relative to 2017?

Well, we'll certainly see it stronger from a couple of things. One, the first one is we will not have the same level of integration costs that are currently embedded in the $475 million-plus number that we've guided to currently. The second is that our belief is that by having the business or the bulk of the business that is roughly 90% of it on a unitary financial system, we can see the same kind of billing acceleration and cash flow acceleration on the acquired business that we've been enjoying in the Leidos business. So it is -- faster billing means faster cash. And we believe that we'll be able to accelerate the velocity of billing on the acquired business. So those are the primary drivers of enhanced cash flow conversion for 2018.

Our next question comes from the line of Cai Von Rumohr with Cowen and Company.

So I think, on the first quarter call, you had mentioned that you'd taken your wrap rates down, I believe, you said twice as a result of kind of cost savings. Could you comment on what have you done with your wrap rates on your bids here in the second quarter and maybe year-to-date. And what sort of impact are you seeing it having on your book-to-bill?

Let's see, Cai, as we look out, we'll probably have another update of the rates towards the end of the year. Those will also be favorable as we get our back-office systems aligned, and able to continue with synergies. And in backlog, it has sort of a short term and a long-term effect. In the short term, on our cost type contracts, it can reduce backlog. But we think in the long term, we become more competitive, and we expect our win rate to increase. And over the long term, it's part of the formula that we have to get to the 3% CAGR, overall.

Of course, we also challenge our program managers when there is a windfall reduction on a contract with a specific customer to engage in dialogue with that customer on enhancements that we can provide and other value-added services to that contract to be able to get that program manager on the customer side to enhance their mission or their program offering. And so we try to challenge our team to go back and capture the cost savings and added scope that's associated with a reduction in cost.

Terrific. And then, May -- I think, on your first quarter call, you'd indicated Q3 the strongest book-to-bill and full year above 1. Maybe, if you could update us on both of those? And comment on recompetes, I gather, you guys were unsuccessful on the NASA mission systems ops bid.

As Jim said, third quarter is always our strongest. And we do what everyone else does. We've got a pipeline, we've got things in flow. We then, through a large systematic process, put probability wins against what's in the pipeline. We generate what our expectation is for third quarter. And that's what has led to confidence in an even stronger third quarter. There is a program at Johnson Space Center. The current contract is called FDOC, Cai, as you alluded to, the recompete. Modified that contract a bit and gave it a new name called MSOC, the Mission Systems Operations Center. There was an announcement of that, the winner of that program.

Another company was announced as the winner. My recollection, I think, there were 3 bidders of which we were one, we were the incumbent. It is my understanding that, that is now under protest. And as such I can't comment much about it because it's in that legal venue. I would only submit that we've had that contract for a long time, by the way. That's to support the operations center for the International Space Station. It's a historic legacy IS&GS contract. It's one that we've had very, very high award fees and have done a terrific job on. We just moved the mission operation center to new technology. And I will say is that, as the protest evolves, we will see where that one goes. And where that may ultimately end up, at this point, is difficult to predict.

And lastly, maybe you could give us some color on upcoming recompetes and maybe your bid pipeline by the 3 sectors, bids outstanding.

That's a tall order. Let me just say that our -- we're happy with our pipeline. We don't see any recompetes that are as significant or material. We're actually relatively happy with our win rate, as we have said at first quarter, I repeat again today, is some of the acquisitions still continue to be delayed. We run about a $23 billion pipeline...

In evaluation.

Yes, which is about where we want to be. And I don't see anything in our business development metrics or the pipeline or our win rate that causes me undue concern. In fact, obviously, I feel better today than I did at first quarter. It's still a very competitive environment. We've got to win business every day. We're still focusing on how we can do that better. And for us, that's a fine to find a way to differentiate ourselves from everybody else in the industry. And we're doing that really through the 3 points that I made on the call, through cost, through technological innovation, and then frankly, making sure that we stay close to the customer.

Our next question is from the line of Robert Spingarn with Credit Suisse.

So I wanted to go back to the organic growth. You'd already talked about the fact that there's some tough comps in the legacy Leidos business. But you also, I think, mentioned that some of the strength that IS&GS was unexpected extension of work, is that the case?

That's clearly part of it. It's not all of it. And the unexpected extension really relates back to this acquisition environment that we have described and I've heard others describe is that new contracts are slow, so existing contracts are being extended beyond what we would have anticipated when we put the plan together at the beginning of the year. We have been a beneficiary of the extensions, which has helped us. And always when they recompete work, they do that to create competition, which can put pressure on margin. So we've had existing business extended. It's usually with a favorable variance to the margin forecast that we would have predicted.

And it seems like given that you've tweaked up the lower end of the revenue guide and we're half way through the year here, well into the third quarter, you're pretty comfortable with your visibility on revenue here in the second half, just given, again, some of these timing differences that seem to have surfaced?

Yes, Rob, I think, you've obviously nailed that one pretty well. Just probably, as you have a model, we have our model and revenue for this year has got to be in the high 90s already in backlog. Because of the time constant in our industry, it's just -- even if we win a program, say, in the third quarter and we ramp up, and we start staffing, it doesn't have a big effect on revenue in the year. And so what you've alluded to is clearly correct. We have high confidence in our revenue forecast for the rest of the year. Because the majority -- the overwhelming majority of that is already in backlog.

Okay. And then just digging a little bit deeper, you talked about a bunch of the awards at the beginning, Roger, some of the new business. Are there some good specific examples of revenue synergies coming through programs that neither of you would have won alone?

Yes, there are -- some of the interesting things we find in our new business is being twice the size. There are very few that are big material revenue movers. And so on any given day, the $1,500 million are coming in all the time. There are some -- I was at an analyst conference a couple of months ago, and I talked about the NMCI, Navy NextGen program, but that's probably 18 to 24 months out in the future as being probably a material contract that we can now bid on that we wouldn't have bid on before. What we're finding now is like I talked about the biometric program is because we've got IDIQ vehicles that we didn't have, we've got technology that we didn't have. We have a more robust pipeline. We're bidding on a broader set of programs with a broader set of customers. It's enhanced our position at places like FAA and CMS and Social Security and VA.

And then, I think, it's really very interesting that Frank Kendall has joined the board. And our experience with him, we always thought of him, and maybe this is incorrect, but as a platform program, hardware acquirer, if you will, obviously, he was doing services as well. But does this position the company maybe to go after little bit more of that core defense hardware or platform work, maybe move a little bit differently than in the past?

Wow, that's a -- boy, that's an insight, I really hadn't given much thought to. Let's see, we are thrilled that Frank joined our board. Frank, as you know, is a West Point grad engineer, lawyer, has an MBA, has been in industry before, has been in government several times. Although, he has got clearly intimate knowledge of platforms because the government buys a lot of platforms. But in his role in AT&L he bought hundreds of billions of dollars of services as well. I would just tell you that he is very, very thoughtful board member. And I think Jim would add, we're quite pleased that he has fully up to speed. He participates very actively in the discussions at the board level. And he brings insight just as our other board members do, John Jumper, who is Head of the Air Force and others and we're just thrilled to have him on the board.

Okay. Just last thing, on the VA contract, I think, you might have talked about it earlier. This is a continuation of work that you've already done. It's a multiple award IDIQ. So this is different than what people have been trying to understand about GENESIS. And the equivalent award to GENESIS at the VA, is there anything you can update us on there?

Okay. Let me spend just a second, and if you will, try to unpack that a little bit. The VA award that I discussed in my statement is not related to electronic health care records. It is actually clinical work that we do around veterans and their health. And it is a program that came to us as part of IS&GS, that they have had for some time that was in protest. That is actually divided by districts, that particular program. And you win and lose different districts, I think, they are up to 6 districts. And we won several of those districts and others won other districts. And then there is some competition around performance in that program.

I would simply say, it had been in protest for at least a year, maybe over a year. It's out of protest. We're off executing. It's a program that we love because we support veterans and veterans' health. I think in your question was the comment or a question really around electronic health care records, the VistA replacement program. I don't have a lot to say there. I will tell you what the facts are as we all know them, that the Secretary wrote, what's called directions and findings, which kicks off an acquisition process to select the electronic health care records off-the-shelf commercial vendor that we are using that's part of the Defense Health Program. And he, in his D&F, he said that the VA will use that electronic health care records systems for the transformation of VistA.

That's really the only news that we can report on. I think the Veterans Affairs has said that we're in negotiation with that party around how that program will look. And that, that process will take several months. Clearly, Leidos has done installation of that health care records system for the Department of Health Affairs. We're in our second. We had our IOC site. We've done our second healthcare facility, we will do 2 more this year. And clearly, Leidos believes we can add a lot of value to the VA program. And we are poised and prepared to assist the VA in any possible way we can.

(Operator Instructions) Our next question is from the line of Ed Caso with Wells Fargo.

It's Rick Eskelsen on for Ed. Just wanted to follow up to Cai's earlier question about bookings, kind of a two-pronged question. First, Roger, in your script, I think you sounded a little more cautious on the award outlook than what we've heard elsewhere in the industry. Maybe if you can talk a little bit more about that, does it just relate to the slowness in terms of staffing up presidential appointees. And then building on, beyond the cost measures that you've taken, can you talk a little bit more about how you've sort of revamped and brought together the business development approaches of the 2 companies and if there's been any areas, especially, within the legacy IS&GS piece that you've been surprised by?

Okay, I'll try to be relatively short because that's a lot to talk about. First, not all companies count awards and backlog the same way. We believe we have a fairly conservative philosophy around how we book IDIQs, both multiple award and single award. So as you compare our number with maybe 2 other companies that recently released, you need to get back to the definition. And I think, we're always trying to be conservative in the way we put our numbers forward. A little bit about business development. We have brought the 2 business development organizations together. We did that on day 1.

We built a business development pipeline. We came to consolidated CRM system. We have -- we de-conflicted the pipelines -- it was just something that we needed to do. And then we have organized in campaigns against the major pursuits that are in the pipeline. There have been and we have seen that acquisitions for which we expected decisions to have been made, have been delayed. In fact, we have seen nothing that has been accelerated yet. Although, there is some talk of that. The trend has been for things to be sole-source extensions, for things to be postponed and NMCI NextGen program, our best read of that is it could be delayed a year. And it was -- it is in our pipeline.

And we have probably pushed it out in our pipeline over a year. What are we doing? We're doing what you would expect. We're looking at our people, our processes and tools around business development. We are looking at how we qualify in the pipeline to make sure that our pipeline is robust. And the good news is we have a much broader set of customers, for which, to pursue new business. And that's been good, but Gerry Fasano, who runs business development and his team are spending a lot of energy to make sure that we are chasing things for which we have a competitive discriminator, either in cost or in innovation.

And I think we've already started to see benefit from that. A program I didn't mention, but clearly is out there, there is a Army field artillery program that we refer to as AFATDS, Army Field Artillery Tactical Data System, again another protest -- another program that had been caught up in protest for a significant period of time, which we had hoped to put in backlog earlier, which I think, we put in backlog, Jim, in the quarter, and it had been delayed at least a quarter, maybe 2, because it had been protested, but it was a nice win for us, and one we won, I believe, because of innovation and a technological discriminator.

Our next question is from the line of Tobey Sommer with SunTrust.

Roger, you alluded to some detail about GENESIS. Could you update us on the expected ramp in that program as you sort of get through the testing phase and a rollout more rapidly?

Yes. But -- we are on track with discussions that we have had previously on the MHS GENESIS or what we call the Defense Health Management Systems Modernization Program. We have 2 more sites, which we really kind of look at as IOC sites this year. We did Fairchild Air Force Base. We did Navy Hospital at Oak Harbor. And we have Madigan and one more site this year. And then we go into what's called waves. And we do -- we ramp up essentially to wave a quarter over the next 12 to 18 months, which will put us sort of -- we'll ramp up, and we will be at sort of that peak installation level for several years. And then at the end of the program, we start to ramp down. So you will see an increase for us in '18 and probably another increase in '19, very consistent with the discussions we've had on that program in the past.

Our next question comes from the line of Krishna Sinha with Vertical Research.

You've raised your integration cost target by about $40 million, is there any cash impact from that?

Yes, there will be, but it is not likely to be seen until 2018. Right now, the program for integration is running really, really well. And while the benefits are taking hold faster than we expected, we're running a little bit under budget so far. So when I think about that increase that we mentioned during the prepared remarks, that's going to happen next year. And I would think of that as maybe the top end of what that estimate would be.

The next question is from the line of Brian Ruttenbur with Drexel Hamilton.

Couple quick questions. First of all, on bookings in third quarter. So you were weak in the first quarter, had good strength in the second quarter. I assume that seasonally you'll have kind of peak book-to-bill in the third quarter, and then a drop off in the fourth quarter, is that what you anticipate?

Let's see -- that's typically and historically what we have done. And we don't guide on bookings. But for all the reasons, we -- our government customers tend to be cyclical, they try to get things under contract before the end of the fiscal year. That's our expectation.

Okay. And as a follow-up, just on recompetes over the next 12 months, what percentage of your base is up for recompete?

Typically, going into a year, what we've said before, and I think it still holds is that about 80% going in, we have visibility on either as run off of existing backlog or follow-on work. So typically, about 20% of our annual revenue though, because the average contract life is 5 years, think about 20% of a given year's revenue going into the year is coming from recompete.

(Operator Instructions) The next question is from the line of Jon Raviv with Citigroup.

Quick follow up. Can you just give us a sense on the first quarter, call you mentioned some unanticipated losses. I'm not sure if the NASA loss was one of those or if that was incremental and to what extent you anticipated it. But you also suggested that you were going to do a bit of a postmortem after those 1Q items. Can you give us an update on kind of what you uncovered and what you're doing to address that and how you see your recompete win rates, perhaps, trending going forward?

Okay. Let may be accurate and factual. The NASA MSOC program was a second quarter event, not a first quarter event. And let's again, unpack that by saying any time you're in a competition, expect to win, I think, that's a strong statement. We're always -- when we're in a competition, we always got to feel like we're in a competition. And I would like to think that we never go in and say, well, this is ours, and we expect to win.

The forensics are, did we write a proposal that reflected our capabilities, and were we scored by the Source Selection Board appropriate with the quality of the innovative solution we put on the table. That's sort of what we assess. And in those competitions where I have been disappointed, I felt like we had a superior solution. We had some great technical differentiators, but we didn't get -- I don't think we got full credit in the evaluation. And so that causes us to go back and say, all right, are we writing good proposals? Are we highlighting our differentiators? Did we get a good understanding of what we call Schedule M, which is the evaluation criteria in the proposal? And sometimes you worry about, well, if you are the incumbent, you can get a little comfortable that your discriminators are well known by a customer and you may not be as precise in your proposal as you need to be. Those are kind of the things that we look at from a forensic standpoint. Did we write a good proposal? First of all, did we have an outstanding solution? And I think we've always proposed outstanding solutions.

But then did we mechanically get that outstanding solution well documented in the proposal that we submitted to the customer such that they evaluated it high and we got high evaluative credit in the way the SSEB, the Source Selection Evaluation Board grades the proposals. And that's what we look at. By the way, we do forensics on all of our proposals, the ones that we win, and the ones that we lose, and we try to understand what do we do well on the ones that we win, and when we lose one, where we thought we had an advantage because we knew the customer well, we knew the solution, or we thought we had a piece of technology that should differentiate us. And we don't win, we always go back and say, okay, what was it that we didn't present well to the customer, and how can we do that better in follow-on proposals.

At this time, for closing remarks, I'll turn the floor back to Kelly Freeman.

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

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