George A. Price - Director of Investor Relations John Michael Lawrie - President, Chief Executive Officer & Director Paul N. Saleh - Chief Financial Officer & Executive Vice President.

Daniel R. Perlin - RBC Capital Markets LLC James Edward Schneider - Goldman Sachs & Co. Jason A. Kupferberg - Jefferies LLC Keith F. Bachman - BMO Capital Markets (United States) Rod Bourgeois - DeepDive Equity Research David M. Grossman - Stifel, Nicolaus & Co., Inc. Frank Carl Atkins - SunTrust Robinson Humphrey, Inc..

Please standby. Good day, everyone, and welcome to the CSC Second Quarter 2016 Earnings Call. Just a reminder that, this call is being recorded, and for opening remarks and introductions, it is my pleasure to turn the conference over to Mr. George Price. Please go ahead, sir..

Thank you, Lori, and good afternoon, everyone. I'm pleased you've joined us for CSC's second quarter 2016 earnings call and webcast. Our speakers on today's call will be Mike Lawrie, our Chief Executive Officer and Paul Saleh, our Chief Financial Officer.

As usual, the call is being webcast at csc.com/investor_relations and we've posted some slides to our website which will accompany our discussion today. On slide 2, you'll see that certain comments we make on the call will be forward-looking.

These statements are subject to known and unknown risks and uncertainties which could cause actual results to differ materially from those expressed on the call. A discussion of risks and uncertainties is included in our Form 10-K, Form 10-Q and other SEC filings.

Slide 3 informs our participants that CSC's presentation includes certain non-GAAP financial measures and certain further adjustments to these measures, which we believe provide useful information to our investors.

In accordance with SEC rules, we have provided a reconciliation of these measures to their respective and most directly comparable GAAP measures. These reconciliations can be found in the tables included in today's earnings release as well as in our supplemental slides. Both documents are available on the Investor Relations section of our website.

Briefly, I'd like to note that Mike's prepared remarks addressing operating results will exclude special items that are discussed in more detail in the non-GAAP reconciliation in our second quarter 2016 earnings press release. In addition, I'd like to also introduce Neil DeSilva who is on the call with us today.

Neil has joined CSC to lead both our commercial M&A and investor relations functions and I'll be working closely with Neil. Finally, I'd like to remind our listeners that CSC assumes no obligation to update the information presented on the call, except of course, as required by law. And now, I'd like to introduce CSC's CEO, Mike Lawrie..

Okay. George, thank you and good afternoon, everyone. Thanks for taking the time with us this afternoon and hopefully, we'll see many of you tomorrow at our Investor Day. As is my practice, I've got several key messages, which will develop a little bit this afternoon and some more that will develop tomorrow in the Investor Day.

But message one is our second quarter non-GAAP EPS from continuing operations was $1.26, up 7% year-over-year. And this was driven by strong commercial margin improvement and strong performance in NPS, as well as a slightly lower tax rate. Our free cash flow was $53 million, which was up $22 million from a year ago.

Our commercial revenue continues to reflect the stronger U.S. dollar and the impact of restructured contracts, though we expect many of these headwinds to moderate in the second half of the year. Notably, we saw some improvement in our consulting business with Americas consulting essentially flat and UK consulting again showing strong growth.

Our commercial book-to-bill was 0.8, but normalizing for a few large deals that slipped into the third quarter and already have been signed, the commercial book-to-bill would have been roughly 1.0.

We continue to see a real positive momentum in our next-generation offerings, which in aggregate, grew 31% year-over-year in constant currency and were also up sequentially. Next-gen bookings were strong with an aggregate book-to-bill of 2.2.

In addition, late in the quarter as we've talked before, we did close our acquisitions of Fixnetix and Fruition Partners, and also announced our potential acquisition of UXC in Australia.

These acquisitions are consistent with our strategy of shifting our mix towards applications, consulting and next-gen, and continuing to moderate our exposure to the traditional infrastructure outsourcing business. Our NPS business continues to produce strong margins, at 16.6%, and again delivered strong bookings with a book-to-bill of 1.5.

I think this bodes well for revenue going forward, although revenue in the quarter was down 7% year-over-year. We had expected revenue to be flat year-over-year with the resolution of a contract dispute, but this resolution was delayed. NPS revenue did grow sequentially.

And we remain on track to separate CSC into two pure-play industry leaders, complete the merger with SRA, and begin trading on the New York Stock Exchange as separate companies on November 30. We also announced our Investor Day, as I said, will be held tomorrow, where we will provide you with many more details about each of these two businesses.

And finally, for fiscal 2016, we continue to target commercial revenue to be flat to slightly down in constant currency and NPS revenue to be slightly up, assuming the contract resolution.

And our fiscal year 2016 non-GAAP EPS from continuing operations, that target remains $475 million to $505 million and our free cash flow target is also unchanged at $750 million to $800 million.

So, let me just develop each of these in just a little more detail and then I'll it turn it over to Paul and we'll then handle any questions that you might have.

As I said, our second quarter GAAP EPS from continuing operations was $1.26, up from $1.18 a year ago, and this was driven by strong commercial margin improvement and strong performance in NPS, as well as a slightly lower tax rate. EPS growth also comes despite the continued headwind we see from currency.

And overall, our operating margin in the second quarter was 12.2%, and this was up 90 basis points year-over-year. Our commercial operating margin was 10.7%, which was up 100 basis points year-over-year, driven by benefits of our cost takeout actions, including our fourth quarter 2015 workforce optimization program.

GBS operating margin was 12.8%; that was up 220 basis points sequentially and relatively flat year-over-year. And the GIS operating margin was 8.5%; this was up 190 basis points year-over-year driven by the benefit of our recent workforce optimization and continued contract restructurings.

The NPS operating margin was 16.6%, and this was up 120 basis points year-over-year and continues to be at the upper end of the industry, driven by continued strong execution. And free cash flow was $53 million for the second quarter and this was up $22 million year-over-year.

Now turning to commercial revenue, our commercial revenue was $1.75 billion in the second quarter. This was down 7.3% year-over-year in constant currency, again driven by the impact of restructured contracts and other headwinds that we've talked about many times in this forum, and this was mainly in our GIS business.

Sequentially, commercial revenue was down 3% and this was consistent with seasonal trends, and in line with our expectations. Global business services revenue was down 4% year-over-year in constant currency, again largely in line with our expectations.

IS&S revenue was essentially flat year-over-year on a constant currency basis and our BPS business, again showed good growth, up 8% year-over-year in constant currency, and our healthcare business was essentially flat.

In consulting, we saw the year-over-year revenue decline moderate to 5% in constant currency, driven by relatively stable revenue performance in the Americas consulting business and continued growth in our UK consulting business, which was up 18% year-over-year in constant currency.

And we expect to see our consulting business continue to show signs of stabilization as we make progress repositioning the business to focus on technology and industry consulting as the tip of the spear for our new and next-generation offerings.

Application revenue was down 8% year-over-year in constant currency with continued runoff as planned in our staff augmentation work and this was – this offset a growth from new work, including apps modernization.

Our Global Infrastructure Services revenue was down 11% year-over-year in constant currency, again largely in line with what we had anticipated.

We continue to experience the effects of price-downs, restructurings and contract completions, which are still ahead of incremental revenue that we're generating from new and traditional offerings, but we are closing the gap as we did in the first quarter.

We continue to close that gap between traditional runoff and incremental new revenue from our offerings, and we'll spend more time tomorrow in the Investor Day talking about this trend and when we can expect to see it cross over. Shifting to contract awards, overall commercial bookings of $1.4 billion represented a book-to-bill of 0.8.

And as I mentioned, a few sizable deals were not signed by the end of the second quarter, but have been signed during the first two – or first few weeks of the quarter. Normalizing for this, our book-to-bill would've been roughly flat at 1.0.

GBS book-to-bill was 0.8 on a reported basis and normalizing for a couple of these contracts would've been 1.1. And GIS book-to-bill was 0.8 on a reported basis and this compares 0.6 a year ago. CSC added 78 new logos in the quarter on a global basis, more than half of which were outside the U.S.

And just to highlight, one of our key competitive wins this quarter came from a major global insurance company, which shows CSC the support its digital first go-to-market strategy.

And as part of this win, CSC will deploy our next generation infrastructure offerings including our private cloud offering, CSC BizCloud, as well as Amazon's public cloud offering orchestrated by CSC's Agility Platform.

And we've also recently signed work with this client to consolidate their existing Oracle state and deliver it at a lower cost as a service.

And I think this example and other examples continues to demonstrate aspects of CSC's strategy in the marketplace, our position as an orchestrator of next-generation technology solutions, our deep industry and domain knowledge and our strong partnerships with technology leaders including Amazon and Oracle.

In fact, if you look out through the balance of this year, over a third of our qualified pipeline now involves one or more of these strategic partners. And turning to our next generation offerings, we continue to see positive momentum in the second quarter and here's just a couple of data points.

Our big data revenue was up 37% year-over-year in constant currency with a book-to-bill of 1.3. Our revenue from our next generation network offering with our partner AT&T was approximately up 20% sequentially and our pipeline for this offering is up over 50% from the year-ago period.

Storage-as-a-service revenue was up approximately 37% sequentially and our storage-as-a-service pipeline is up 70% year-over-year. Standalone cyber revenue was up approximately 36% year-on-year in constant currency, and our applications modernization revenue was up approximately 31% sequentially.

And our pipeline for that offering is also up over 20% year-over-year. In aggregate, revenue from our next generation offerings was up approximately 31% year-over-year in constant currency and had a cumulative book to bill of approximately 2.2x.

And also, during the quarter, we introduced a groundbreaking next generation network offering with our partner AT&T.

We integrated our Agility Platform, which manages the orchestration of applications in a hybrid could environment with AT&T's NetBond, which establishes a fast, secured network link from the enterprise to public clouds like Amazon and Azor.

And this offering enables our clients to quickly configure both the cloud environment and the secure network in an integrated manner, removing a key obstacle to broader public and hybrid cloud adoption with our clients globally. And late in the quarter, we – as we previously disclosed – we did close on Fixnetix and Fruition Partners.

As you know, Fixnetix is a leading provider of managed services in the financial services industry and Fruition Partners is the leading global integrating partner for ServiceNow a leading provider of enterprise service management solutions. And in addition, we announced that we've entered into due diligence to potentially acquire Australia-based UXC.

UXC is the largest independently owned IT services provider in Australia. Now assuming our acquisition moves forward, UXC would bring an attractive mix of offerings with approximately two-thirds of its revenue in applications, consulting and next-gen areas, as well as help CSC expand in attractive verticals like consumer and retail in Australia.

And these acquisitions are consistent with our transformation strategy by shifting our revenue mix to offerings that we think over time will generate better growth, better profitability and cash flow. So, let me now turn to the NPS business. NPS revenue was $967 million in the second quarter. This was up 1% sequentially.

On a year-over-year basis, NPS revenue was down 7% due to program completions, reduced task orders, which more than offset some of the new work. We had expected, however, revenue to be flat on a year-over-year basis in anticipation of the resolution of a contract dispute, which was delayed.

Our NPS operating margin was very strong at 16.6%, up 120 basis points year-over-year, driven primarily by our continued strong execution. NPS bookings were $1.5 billion in the quarter for a book-to-bill of 1.5, an improvement from 1.1 a year ago. And during the quarter, we won a key deal with the U.S.

Federal Aviation Administration to consolidate its datacenters and migrate data and systems to a hybrid cloud environment using our Agility platform. We won this deal with the help of some of our key partners, including Amazon, Microsoft and EMC.

And the third quarter is off to a good start for NPS, having already signed $1 billion in TCV so far this quarter.

Our NPS qualified pipeline is $13 billion, which includes $1.9 billion of next generation services and our submitted proposals awaiting award totaled $3.8 billion at the end of the second quarter, nearly 40% of which were for new work to CSC.

NPS's overall performance continues to put it near the top of its peer group and positions it along with SRA for a strong market launch later this month.

In fact, SRA filed an 8-K earlier today with strong preliminary results for the September quarter, including year-over-year revenue growth of 4% and a book-to-bill of 2.3x In terms of the separation, we remain on track to separate CSC into two publicly traded industry-leading pure play companies.

In fact, our second quarter earnings release today represents the last quarter that CSC will report the NPS business in its results from continuing operations. During the quarter, we completed additional important steps on our journey to separation.

We filed amended versions of our Form 10 with updated information, including and related to our anticipated merger with SRA. We named David Keffer, SRA's Chief Financial Officer as the CFO of the new company, and we've also added a number of other key leaders as well as additional members of the new company's board of directors.

Now, subject to satisfaction of customary conditions, we expect to complete the distribution of public sector shares to our shareholders after the market closes on November 27, 2015. And following that distribution, we will pay a special cash dividend of $10.50 per share. Payment of this special dividend will be made on November 30.

The holders of CSC common stock on November 18 record date will receive public sector shares in the distribution. And also subject to satisfaction of customary conditions, we remain on track to complete the merger of our public sector business and SRA on November 30, 2015. Following the separation, the new company will be named CSRA.

And with all of this completed, we expect to begin trading as two separate independent public companies with the tickers CSC and CSRA, with the New York Stock Exchange – or when I should say – the New York Stock Exchange opens on Monday, November 30.

And as I said earlier, we will hold an Investor Day tomorrow here in New York where we'll introduce and discuss our two new industry-leading companies in greater detail, and this event will be webcast on CSC's Investor Relations website.

Just to wrap up here, before I turn it over to Paul, for fiscal 2016, we continue to target GBS revenue to be up slightly and for GS revenue to be down in the mid-single digits, both on a constant currency basis.

And this equates to commercial revenue being flat to slightly down in constant currency, though I'd say the current bias is to the lower end of that range. And we also continue to target NPS revenue to be up slightly in fiscal 2016, again, assuming the favorable outcome of the contract dispute that I mentioned earlier.

And along with our commercial revenue expectations, this translates into total revenue being flat to slightly down on a constant currency basis, and we continue to target non-GAAP EPS from continuing operations of $4.75 to $5.05 for fiscal 2016.

We expect the margin benefits from our workforce optimization actions to be more pronounced in the second half of the fiscal year, and we continue to target free cash flow of $750 million to $800 million. So with that, I will turn it over to Paul Saleh.

Paul?.

Thank you, Mike and good evening, afternoon, everyone. Before I review the second quarter, let me cover a few items that are included in our GAAP results. First, we had $48 million or $0.30 per diluted share of separation, merger and other transaction costs in the quarter. Second, we had $2 million or $0.01 per diluted share of SEC related costs.

Third, we had $21 million or $0.14 per diluted share of real estate restructuring charges to accelerate facility consolidation. And lastly, we had a tax benefit of $53 million or $0.38 per diluted share related to the favorable resolution of a tax valuation allowance in the UK.

Now these special items, which cumulatively represent an impact of $0.07 per diluted share, have been excluded from our non-GAAP results for the quarter. Now, turning now to our second quarter results, revenue in the quarter was $2.7 billion, down approximately 7% year-over-year in constant currency.

On a sequential basis, second quarter revenue declined slightly, in line with our expectations and reflecting the typical seasonality we experience in our business from Q1 to Q2.

Operating income adjusting for the special items I previously discussed, was $331 million and operating margin was 12.2%, up 90 basis points over the prior year, driven by improvement in our commercial profitability, particularly in GIS, as well as continued strong execution in NPS.

Earnings before interest and taxes adjusted for the special items was $275 million. EBIT margin on that basis was 10.1%, up 110 basis points from a year ago. Non-GAAP diluted EPS from continuing operations was $1.26, up 7% from a year ago.

And our effective tax rate in the quarter was 26%, slightly lower than our target range for the year, driven by our global mix of income. Bookings in the quarter were $2.9 billion, down 3% year-over-year and overall, our book-to-bill was 1.1 times. Now let's turn to our segment results.

GBS revenue was $891 million in the quarter, down 4% year-over-year in constant currency. Adjusted operating income for GBS was $114 million in the quarter. Our adjusted operating margin was 12.8%, up 220 basis points sequentially and relatively flat on a year-over-year basis.

GBS bookings were $682 million in the quarter for a book-to-bill of 0.8 times on a reported basis, and our booking reflects the impact of a couple of large deals that slipped into the third quarter, but have since been signed.

Turning now to our Global Infrastructure Services; GIS revenue was $854 million in the quarter, down 11% year-over-year in constant currency. The GIS revenue decline reflects the impact of contracts we've restructured over the past year, as well as other contract completions and price-downs.

Adjusted GIS operating income was $73 million in the quarter, adjusted operating margins was 8.5%, up 190 basis point year-over-year as we benefit from our workforce optimization efforts. Our bookings for GIS were $702 million in the quarter for a book-to-bill of 0.8 times compared with 0.6 times a year ago.

Turning now to our North American Public Sector business. NPS revenue was $967 million in the quarter, down 7% year-over-year, but up 1% sequentially. We were expecting revenue to be flat on a year-over-year basis, with a resolution of a contract dispute, but this resolution was delayed.

Adjusted NPS operating income was $161 million in the quarter and our adjusted operating margin was 16.6%, up 120 basis points from the prior year reflecting the benefit of an amendment to a contract that allows us to recover costs previously incurred.

Our NPS bookings were $1.5 billion in the quarter, up $1.1 billion – up from $1.1 billion a year ago – and our book-to-bill was 1.5 times versus 1.1 times last year. Now, let me turn to other financial highlights for the quarter. Our free cash flow was $53 million in the quarter, an improvement of $22 million from a year ago.

Our year-to-date free cash flow is $170 million, up $69 million year-over-year. Free cash flow excludes the impact of special restructuring payments, separation, merger and other transaction payments and SEC settlement related payments. Our free cash flow also excludes any benefit from our NPS receivables securitization facility.

A reconciliation of free cash flow can be found in the back of our Q2 earnings slide deck and in our earnings press release. CapEx was $215 million in the quarter, compared with $203 million a year ago. And the year-over-year increase was driven primarily by timing of software purchases.

On a year-to-date basis, CapEx was $385 million at the end of the second quarter, compared with $402 million a year ago. Cash on hand at the end of the quarter was $1.8 billion versus $2.2 billion last quarter and $1.9 billion a year ago.

In the quarter, we paid $32 million in dividends to our shareholders, and also in the quarter we invested approximately $230 million in the acquisition of Fixnetix and Fruition Partners. Our net debt to total capital ratio at the end of the quarter was 14% compared with 13.2% a year ago.

In closing, let me review the targets that we have for the full year. Target revenue for fiscal 2016 remains flat to slightly down in constant currency. NPS revenue's targeted to be up slightly for the year assuming the favorable resolution of the contract dispute we highlighted earlier.

Commercial revenue's targeted to be flat to slightly down in constant currency for the year, although the current bias is toward the lower end of that range. Currency at this time represents approximately 400 basis points of headwind to commercial revenue in fiscal 2016 and approximately 300 basis points for the whole company.

And for the third quarter, we're currently targeting commercial revenue in the quarter to be up sequentially and relatively flat on a year-over-year basis, both in constant currency. Similarly for the NPS business, we currently are targeting revenue in the third quarter to be up sequentially and relatively flat on a year-over-year basis.

Currency at this time in the third quarter represent a year-over-year headwind of approximately 400 basis point for commercial revenue and approximately 250 basis points for the company overall.

And for the full-year fiscal 2016, we continue to target a non-GAAP EPS from continuing operations of $4.75 to $5.05 and our EPS target assumes a tax rate in the range of 28% to 30%, although we're currently trending toward the lower end of that range.

Our EPS target excludes the impact of special items such as mark-to-market pension accounting and separation, merger and transaction costs. And finally, our free cash flow target for fiscal 2016 remains $750 million to $800 million. Now I'll hand the call back to the operator for the Q&A session..

Thank you, sir. Today's question-and-answer session will be conducted electronically And going first to Dan Perlin at RBC Capital Markets..

Thanks, good evening and looking forward to tomorrow. The question I have on GIS, Mike, I guess, is really this. When we look at all the kind of incremental growth opportunities, it sounds like you're creating a next generation offerings.

Where are we in the process for that to start to overtake, what has otherwise been, some challenges in terms of renegotiating and restructuring these contracts?.

Yeah. We're going to get into this in a little more detail tomorrow, but I think, let's put it like this, we see that crossover point certainly in sight. I wouldn't just narrow it down to GIS. I'd want to include all of our next generation offerings. So that'd include application, modernization and the improvements we're making in consulting.

So, I think, when we add those all up, we see that coming sometime within the next year or so. And we'll go through that in much more detail tomorrow, when we see that crossover point and what makes up that crossover point..

Okay. That's great. And then one other one real quick. Just as we think about the kind of consulting business today, you talk a little bit about the European side of that – UK side of that growing – and then the Americas kind of flat.

I'm just wondering if you could elaborate on some of the dynamics that you're seeing that are causing a some divergence or maybe even a large divergence? Thanks..

Yeah. The primary differences, we began to implement this new approach to consulting in the UK first. And we made a big investment, we hired people, we got those people deployed. They've been able to build a pipeline and we're now converting that into revenue.

So, we piloted this approach, and this approach is fundamentally about consulting around technology. So, going in and helping clients figure out how to make this transition from, what I'll refer to as traditional infrastructure, to next generation or cloud infrastructure.

Go in and consult on how you begin to do a taxonomy of your application portfolio, what applications need to be retired, those that need to be modernized, et cetera, et cetera.

And that was piloted first and we're now in the process of implementing that in the United States and we saw some improvement in the United States in the second quarter and are forecasting continued improvement in the second half.

So that's the difference is we implemented that new model around technology consulting first in the UK and then second in the United States..

Okay. That's great. And then one last one. As your clients are all pivoting to digital and these other new agendas, where do you stand or, I guess, what is the strategy still in order to achieve and attract the kind of talent that's necessary to really implement all of those changes on behalf of your clients? And looking forward to tomorrow, thanks..

This is something we're going to cover in a little more detail tomorrow. But right now, we are hiring between 400 and 500 people a week in this company worldwide.

Now most of those skills are targeted at certain technology areas, certain skill sets and most of those hiring are taking place in our lower cost locations like Vietnam and India and Lithuania, et cetera. And at the same time, through this workforce optimization, we've got several hundred people that are exiting the business on a global basis.

So this is a huge transformation of the technical resources we have. In addition, we've also launched significant training of our existing population. So we've now instituted that through what we call the CSC University and many of our people are undergoing retraining, so that we can continue to add relevant skills to our clients and capabilities.

And of course, we're also, with these acquisitions that we are making, we just talked about bringing in substantially new skills as well..

Excellent, thanks..

We'll go next to Jim Schneider at Goldman Sachs..

Good afternoon. Thanks for taking my question.

I was wondering if you can maybe talk about the kind of continued progress on the offshoring in the commercial business? Kind of give us an update on a percentage basis where you stand today, and again, maybe you'll cover that tomorrow in more detail, but where you think you're going to be say at the end of calendar 2016 or at some other point out in the future?.

Yeah, we're roughly at 45% now. So this has gone up a couple of points over the last several quarters, and our plan is to drive that over the next several years to at least 55%. So we've made progress.

And again, with this rehiring, when you're talking about hiring 400, 500 people a week in these locations, that also helps you rebalance the workforce on a global basis..

That's helpful. And then, maybe just on the bookings front, it could be you already covered this and pardon me if you did, but can you may be talk about the GBS bookings, and I understand they can be lumpy.

But specifically, have you seen any kind of deceleration and if so, in what sub-segments or industrial segments within your base?.

No, we haven't seen a deceleration. I mean, we had a fairly large BPS transaction that we had in the second quarter a year ago and we had another large one which we did not close in the second quarter. We expected to close it – we didn't – and now it's been closed. And some of these things are lumpy.

We're not particularly in the game here of lowering the price at the end of a quarter just to get somebody to sign. I'd rather maintain the margin and sign it two weeks later. So, there's no deceleration, it was just a matter of timing..

That's helpful. Thank you so much..

And we'll take our next question today from Jason Kupferberg at Jefferies.

Sir?.

Thanks guys. So, just to push on the full-year revenue a little bit and try and get some more visibility there. I mean, if you hit the Q3 guide that you gave for the two segments, I think you still need a pretty big hockey stick in Q4 to get to these full-year targets.

And I can appreciate, especially in commercial, the year-over-year comps get a lot easier.

But how much do some of the recent acquisitions maybe help you get there, and then on the NPS side, what would be the drivers?.

Yeah. Well, on the NPS side, as I said, we had this contract which we expected to resolve in the second quarter; we didn't get it resolved. Frankly, we were surprised that it didn't resolve, but we're hopeful that that gets resolved as we go forward here. So that pretty much explains the difference in NPS.

On the commercial side, we do see our application in GBS beginning to accelerate on a year-over-year comparison basis in the second half of the year, and we're beginning to see some moderation in the GIS business as we begin to wrap around and some of those contract restructurings that we've talked about, work their way through the cycle.

In addition, we continue to see strong growth in the next generation offerings. The revenue there, I think I mentioned, was up 30-some percent in the second quarter. We continue to see that grow out through the second half. I think the bias here is probably the commercial revenue will be the low end of the range.

But that's what makes up the projections. I don't know Paul, if you want to add anything to that..

I just would – you had asked a question about Fruition and (41:12)..

Oh, yeah, that's definitely is in. Yes..

That's about maybe about $75 million to $80 million of incremental revenue into the second half..

Okay. That's really helpful. And just any update on cross-selling strategy. I think I remember in the past you had mentioned that only about 10% of your clients are being cross-sold.

Has that number been inching up?.

Yeah, we're making more progress on that as we being to transition clients from a traditional infrastructure to next gen. We're going to detail a couple of these examples tomorrow to show what happens when you begin to transition a client. So, what do you lose? Because we've said before on these calls, there is some cannibalization here. And then....

Right..

...what are the additional services that usually can get wrapped around those next generation offerings to make up for some of that cannibalization. So, we will go through a couple of real live examples where we're either have done it or we're in the process of doing it; I think that will shed a little more light..

Okay. And then just a quick clarification.

How much revenue does the NPS contract resolution represent?.

Probably somewhere in the neighborhood of $50 million to $60 million..

Terrific. Thank you, guys..

And we'll go next to Keith Bachman of BMO Capital Markets..

Many thanks. I also wanted to ask about the free cash flow for a second.

Just so I'm clear, the $75 million to $80 million that's the guide for the year, that doesn't include one-time items such as the sale of the NPS accounts receivable? If you could just clarify that?.

Yeah, first of all, it's $750 million to $800 million..

Yeah, sorry. I beg your pardon – we've had a lot of calls – $750 million to $800 million..

And then secondly, you're absolutely right. We will – it does not include the sale of receivables to – through that special facility that we have. So we normalized for it. We exclude it in calculating our free cash flow..

Okay. Great. Thank you. And then, just a follow up on the margin side for the commercial sector.

How are you thinking about, as you're ramping incremental low cost head count, if you will, getting up to maybe the 55% level versus the mix of the portfolio that you have in terms of bids in front of you and what not, how are you thinking about the operating margin structure as you look out over the next few quarters?.

Yeah. Again, tomorrow what we're going to take you through is a roadmap that....

Okay..

...details the margin expansion we think we can get by the continued shift in our mix of business. With some of these acquisitions that we've either made or some of the ones we are working on, plus the continued growth of our next generation offerings, this portfolio is beginning to remix.

And as the portfolio remix, that drives higher margins and we're going to detail what our model is for the, think of this as the bps [basis points] growth with that offering remix..

Okay..

The other thing is we are beginning to introduce automation, particularly into our GIS and other delivery capabilities. That too will drive some margin expansion. And then, the recalibration, or the optimization of the workforce, including continuing to move to lower cost near-shore and offshore and continued work around re-pyramiding our workforce.

What we'll do is we'll take you through what we think that will drive in terms of margin expansion over the next several years. But needless to say – just I don't want to anybody to lose sleep thinking about this tonight – there is a margin expansion opportunity as we remix, re-optimize and retrain our workforce, particularly our delivery workforce..

All right. Many thanks, Mike. We'll look forward to that tomorrow..

Okay..

And we'll go next to Rod Bourgeois at DeepDive Equity Research..

Hey, guys. Hey, I want to ask more about your GIS operating margin. It was encouraging to see that up 190 basis points year-to-year to 8.5%. We haven't seen that level in a while. Were there any lumpy contributions to the GIS margin in the quarter? And more importantly, I mean, you mentioned cost levers to continue to drive margin expansion.

Do those cost levers also apply to a margin expansion plan from here in the GIS business as well?.

Yeah. The latter – the answer to your second question is, yes. We do see continued margin expansion, largely driven by the optimization of the workforce and the introduction of automation. Those are the primary drivers in the GIS business.

I'll let Paul talk about any lumpiness, but we did see some margin expansion in the quarter, due to the workforce optimization program that we announced. Remember we took that big....

Yeah..

...restructuring charge in the fourth quarter and that is now beginning to work its way through the system, particularly in Europe. So...

Yeah.

No, actually, Mike you just already touched on those items and I think tomorrow we'll be outlining them in actually more detail in each of those categories, but absolutely, the $245 million of investment that we took in the fourth quarter is starting to show in through – particularly in GIS – it was to the tune of close to $15 million to $20 million..

Great.

And then, Paul, was there any lumpy contributions in the GIS margin in the quarter or was that all really coming from the workforce optimization?.

No, it's primarily for workforce optimization. Actually, the continued – also – work that the business is doing – going to what we – we have a number of initiatives underway to look at efficiencies.

You're starting to see also the benefit of what we call our TOPS (47:45) program, where we just really make sure that we manage the transition of completed contracts and the like.

Some of the contracts also that we lost were coming in – remember, we just – didn't just restructure contracts for the heck of it, we did it just with the intent of improving our margin. And some of the contracts that we restructured had low margins or where – were basically losing margin.

So that you're starting to see some of that being reflected in the overall profitability of the business..

And Rod, there was one contract, that we know we're no longer involved with that had significant margin improvement, although we actually only got one month credit for that because it was resolved in, I think, the end of August or September. I don't want to mention any names here.

So that was one of the things and then the one thing we haven't talked about is – and Steve Hilton will be at the Analyst Day tomorrow – we're making some real progress with our suppliers.

So, we are taking a look at some of our agreements that we have in place as part of the separation and we're making some improvements from a supplier standpoint as well..

Got it. Okay. Hey, and just a clarification on the NPS contract dispute.

If that contract dispute gets resolved in the way that you now expect, will this produce a one-time revenue contribution or will that be kind of the add back of a recurring revenue addition?.

No, it's a one-time..

Okay. Thanks guys..

Moving next to David Grossman at Stifel..

Thank you. I wonder if we could just talk a minute about the gross margin. I know that's a line item you don't necessarily calculate on your P&L. But, just when you back out cost of sales, it looks like that gross margin calculation is down on a year-over-year basis, both in the first and the second quarter.

So, if that's an accurate depiction of what's going on, could you help us understand what the primary drivers of that dynamic are, particularly given the scale of last year's rebalancing charge?.

Yeah, I think it is a good question and what – there's a couple of things going on.

Number one, and obviously there are certain category of costs that we're taking them out of as we centralize certain activities, certain costs, that come out of cost of sales for example and go – in our, in the – in what we would call the SG&A kind of activity and vice versa.

So, as we were kind of refining our entire cost structures, we found that there were costs that were really in the wrong category. So we've been fixing that as we go. Second of all, you have to remember that our top line has come down in constant currency and we're still in the midst of changing the workforce to low cost market.

And so, sometimes you're going to see the gross margins where they're reflecting that transition of work that's taking place. So, for example, when we're talking about hiring in offshore, we still have train these folks.

We also have knowledge transfer that has to be taking place before, we just really get the full benefit of exiting people out of our organization. We're doing it with the mindful of making sure that we meet our customer commitment for SLAs and the alike.

So, sometimes you're going to see the gross margins really reflecting the investment that we are making in those areas..

Okay. Thank you for that. And then, I guess again on the margin, so, but looking at it by segment. The NPS operating margins remain well above the industry average as you've mentioned several times. And I thought you may have said, there was a recovery in the quarter or maybe I got that wrong.

But that aside, can you help us better understand what it is that gives you the confidence that, that margin level, well above the industry average is sustainable, once the business starts growing again?.

Listen, we're going to get into this in more detail tomorrow when we kick off CSRA. But it's not complex. The mix of our business is much higher around fixed cost contracts. And our execution on those fixed price contracts is driving margin expansion, as opposed to time and material of a business.

And our mix is much, much higher around those fixed contracts, which we are managing very well. In addition, 75% of our business portfolio is IT. So, we don't have a lot of other cost plus and other mission work. And then finally, I mean, we took some really strong actions two years ago. We took a lot of cost out of this business.

No one thought we could do it, and we did it. Now we gave up revenue because you wind up billing the government less because you've reduced the cost, but that gets you a much leaner cost structure. In addition, no one said you could have a low-cost labor strategy in NPS.

Well, that turned out to be a bunch of baloney, because we did this deal in Bossier City and we've now moved, I don't know, Paul, 300, 400 jobs ....

500 jobs..

500 jobs. And that's got a cost – a labor cost of $0.70 on the $1. So you add up mix, you add up the structure that we took out and you add up what we're doing from a low-cost delivery standpoint, that's how you get to better margins than our peers..

Right..

And I'll argue they'll do the same thing as they go forward..

Right.

So, and your feeling is that, if this business starts to grow again, that this margin level is sustainable even with growth?.

Yeah. And that's exactly what we're going to share tomorrow is how we think we can sustain these margins. I'm not saying we're going to sustain 16.6%, but substantially we've been running this thing 14%, 15%, 16%, in that range. Yes, we think these margins can be maintained..

Okay. Very good. Thank you..

Lori, let's go ahead and take the last question..

We'll go to Frank Atkins at SunTrust..

Thanks for taking my questions.

Just want to ask on the GIS side, any changes in pricing there as you go forward? Have there been any changes on that commercial side?.

No..

Okay.

And then any incremental investments that you think will still need to be made as you adjust these two businesses? I guess, I'm sure that you'll talk about that's more of – incremental probably?.

Yeah. I will talk a little bit about – more of that. Yes, we will continue to make investments and outline where those investments are, both in people, in retraining. The big investment is around people; there's investments that need to be made in tooling and automation.

So, yes we will detail those tomorrow as well as some of the investments we're making with our partners in our offerings..

All right, great. Thank you..

Okay, guys. Thank you. See you tomorrow..

Thanks very much, everybody for joining us, and we look forward to seeing you tomorrow. Have a good evening..

Ladies and gentlemen, once again that does conclude today's conference, and again, I'd like to thank everyone for joining us today..