Kelly Freeman - Leidos Holdings, Inc. Roger A. Krone - Leidos Holdings, Inc. James C. Reagan - Leidos Holdings, Inc..

Cai von Rumohr - Cowen and Company, LLC Rick M. Eskelsen - Wells Fargo Securities LLC Noah Poponak - Goldman Sachs & Co. LLC Jon Raviv - Citigroup Global Markets, Inc. Krishna Sinha - Vertical Research Partners LLC Robert M. Spingarn - Credit Suisse Securities (USA) LLC Greg Konrad - Jefferies LLC Brian Ruttenbur - Drexel Hamilton LLC.

Greetings and welcome to the Leidos Fourth Quarter and Full Year 2017 Earnings Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Kelly Freeman, Director of Investor Relations Please go ahead..

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our fourth quarter and full year 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 December 29, 2017. Roger will lead off the call with notable highlights from the year as well as comments on the market environment and our company's strategy. Jim will follow with a discussion of our financial performance and our guidance expectations.

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

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

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

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

Thank you, Kelly, and thank you, all, for joining us this morning for our fourth quarter and fiscal year 2017 earnings conference call. Leidos had another great year of performance in 2017 with many operational successes resulting in strong financial results.

I want to start my commentary by thanking our employees for their dedication to the significant effort incurred to realize the potential of our transaction.

Our employees were able to stay focused on delivering for our customers and finding new opportunities to grow the business while making the difficult decisions required to drive synergy and become leaner and more agile as an organization, as we exited the integration of the IS&GS Business.

As a consequence of this activity, I am proud to report some of the more notable highlights of our 2017 results. Adjusted EBITDA margins increased by 145 bps from the prior year to 10.4%, driven in large part by delivering strong program performance and outperforming our cost synergy targets.

Our commitment to delivering innovative solutions to our customers on time and on budget has been recognized and rewarded. We emerged from the integration with an even stronger culture, focused on agility and innovation. I'm especially pleased with how well the team has come together at all levels of the organization.

At Leidos, we are building the going-forward culture of customer focus, delivery on commitments, and taking care of our people.

We designed an organization that can offer our customers a wide portfolio of solutions to their toughest problems, from those requiring the leanest of cost structures to those requiring the most high end technical capabilities. This flexible approach positions us well to grow our business.

We booked roughly $10 billion of new awards into backlog and continue to await decisions on another $24 billion of submitted proposals. We generated over $0.5 billion of cash from operations and returned $198 million to shareholders through dividends while deploying $209 million to lower our outstanding debt.

More importantly, as we look to drive growth across our business, the investments and focus on improving our business development activities and processes has resulted in improved win rates.

While this takes time to translate meaningfully to revenue, it certainly increases our confidence in the actions we are taking and the strategy against which we are executing. As we look to 2018 with the majority of the integration activities having been successfully concluded, we are more singularly focused on growth.

With the right cost structure, the right portfolio of capabilities and the right people in place, we are eager to deliver innovative solutions at best value to more customers around the world. As Jim will detail for you further in his remarks, we expect to grow the business in 2018.

This expected inflection in our growth rate in 2018 reflects the impact of our 2017 accomplishments. First, in 2017, we continued to optimize our cost structure, resulting in more than $350 million of cost synergies achieved thus far, considerably more than we had expected at the onset of the deal.

However, this resulted in a growth headwind in 2017 due to decreased revenues on cost-plus programs. With most of the cost reduction activities now concluded, we do not expect to see this effect in 2018, thus removing this headwind from our future. Additionally, during 2017, we added 28 IDIQ vehicles to our already broad portfolio.

While these don't contribute materially to our backlog in the year, we believe we are well positioned to recognize tangible value from these vehicles, further aiding our growth in 2018.

Finally, as we have shared with you, since the transaction closed and continuing through 2017, we have taken actions to improve our business development processes and modernize our proposal center.

The improvement in win rates we have experienced as a result of these actions gives us greater confidence in the expected return on our bid and proposal expenditures. As such, we are increasing our investment in this area in 2018.

We remain focused in our BD activities on leveraging our lean cost structure and broad technical capabilities to deliver better value and more innovative solutions to our customers. Notably, just since the beginning of the year, we have won several significant programs. A few highlights to share on these.

We successfully defended a 2017 protest on a single-award IDIQ fixed price contract with the National Geospatial-Intelligence Agency which has a five-year ordering period and a total contract ceiling of $988 million. We have already received the first task order and begun work on this contract in the future.

We also successfully defended our incumbent position on a couple of re-competes with classified customers and received approximately $500 million of awards on these in the first quarter.

These successes, combined with the improved win rate and the incremental investment we are committed to our new business development activities, give me confidence that we are positioned for and executing on a strategy designed to deliver top line growth at or above our long-term margin target.

Also increasing our confidence in 2018 and beyond is the recently passed two-year budget agreement authorizing a record budget for The Pentagon at roughly $700 billion for defense in 2018 and $716 billion for 2019.

As most things do in Washington, the budgetary environment has evolved differently than I believe many were expecting a year ago and that the expectations of a higher level of defense spending has taken more time to work through the budgetary process.

The recent budget agreement includes three key aspects, which we believe will provide nice tailwinds to the industry. First, the agreement removes the budget caps for 2018 and 2019 and removes the debt ceiling. Second, the agreement includes very strong budget authority numbers for both national security and civil agencies.

Third, the two-year agreement suggests a predictable and hopefully a timely start for fiscal year 2019, allowing for the possibility of noticeable improvement in the procurement environment.

That said, increases from the new government fiscal 2018 and 2019 budgets will take time to materialize into revenue given the lag between outlays and budget authority, but we do expect to benefit from a higher level of outlays in 2018 associated with prior year budgets.

The appropriation bills will provide additional detail in the coming weeks, but we continue to believe we are well positioned with the stated defense strategy to benefit from these tailwinds.

Before I hand the call over to Jim to provide more details on our financials and our guidance, I want to spend a moment discussing the impact of the Tax Cuts and Jobs Act on our business. Although we are still evaluating some of the elements of the act, we are prepared to discuss a few areas at this time.

First, as a near full rate taxpayer, we expect to see a material reduction in our overall effective tax rate due to the new 21% federal rate. Second, we plan to invest more in our bid and proposal area through specific initiatives targeting increased top line growth.

Third, we plan to invest more in technology and capital to increase our advantage in offering innovative solutions to our customers. Finally, we remain committed to our capital deployment philosophy.

As we have consistently indicated, we consider a number of options for capital deployment, including regular dividends, share repurchase, debt reduction and investing for growth in the business both organically and through M&A.

On this topic, we announced this morning the approval by our board of a share repurchase authorization up to 20 million shares. This will allow us additional flexibility to deploy our excess cash.

In the near-term, we expect to be in the market from time to time in order to, at a minimum, offset the effects of share creep from our compensation programs. Now, I'd like to spend a moment to thank our former Chairman and CEO, John Jumper, for his service to Leidos.

As you may have seen earlier this week, we announced John's intent to retire from the board at the end of his term in May. Throughout John's 11-year tenure with the company, his legacy of leadership and counsel set us on a path that will endure as we continue to grow Leidos as a global technology leader.

John came to Leidos after a long and decorated career in the United States Air Force, retiring in 2005 as its Chief of Staff. In conclusion, I am pleased with the results of our fourth quarter and fiscal year 2017.

And I am confident that the efforts we undertook to improve our cost structure and increase our technical capabilities will serve us well in driving growth in 2018 and beyond. With that, let me hand the call over to Jim Reagan, Leidos' Chief Financial Officer, for more details on our results and 2018 outlook..

Thank you, Roger, and thanks, everyone, for joining us on the call today. I'll start first with remarks on the impact of the Tax Act before providing thematic commentary around the numbers we released this morning.

The reduction in the federal corporate rate resulting from the Tax Act does enable a reduction in our non-GAAP effective tax rate beginning in 2018, whereas previously, we have suggested a nominal tax rate in the mid to high 30s inclusive of state taxes, we're – we now expect our effective tax rate to be in the 23% to 24% range.

Consistent with the intent of the Tax Act, we plan to invest some of these below-the-line savings to enhance the growth of our business. Specifically, we intend to increase our bid and proposal budget to better execute against our growing pipeline.

As the investment within the company that generates the highest ROI and particularly with the improving win rates that Roger indicated, we believe that the returns here will be meaningful to the business. Additionally, beyond the reduction in the corporate tax rate, the act included several changes to other tax provisions.

One of these allows for the immediate expensing of capital assets beginning in the fourth quarter of 2017, which accelerates the after-tax returns on such capital investments. With immediate expensing and lower rates, we now have a broader portfolio of investments that meet our acceptable threshold for ROIC.

While most of our CapEx investments to-date have been facilities-related, we have always evaluated a select set of technology investments as well.

We remain committed to our capital-light business model, but we now have some opportunities where increased CapEx investments will enable us to exploit our technical discriminators that we expect will ultimately generate higher returns.

As such, we expect to increase capital investments in 2018, with $80 million being a new steady-state level of CapEx for the company, up from our prior view of roughly $60 million. Additionally, due to the 2017 enactment date of the Tax Act, we did see some benefit in the fourth quarter, which I'll touch on shortly.

Let me now spend a moment on our full-year 2017 results. Overall, we are pleased with the strong results we delivered in 2017, particularly against our cash and margin targets and more so with how well we believe we are positioned going into 2018.

I'll start with a few highlights from our full-year results before discussing our fourth quarter performance. First, margins for the year significantly exceeded our initial views of 9.5% to 10%, with adjusted EBITDA margin of 10.4%.

This was accomplished through intense focus on excellent program performance as well as diligent efforts by all of our employees in driving cost synergies from the business. We realized more than $350 million of annualized gross cost synergies through the end of 2017.

Approximately half of that went directly back to customers on our cost-plus-type contracts, resulting in some headwinds to revenue as Roger mentioned. We invested a portion of the other half to improve our offerings and competitiveness and drive growth as well as drive improved operating margin.

We generated $526 million of cash from operations in the year and prudently deployed that to three primary areas. First, we returned $198 million to shareholders through our regular quarterly dividend. And second, we reduced our debt by $209 million bringing our total net debt position at the end of the year to $2.7 billion.

Of our total outstanding debt, approximately two-thirds is fixed rate and one-third is floating after adjusting for the swaps that we have in place.

And third, we spent $81 million on capital expenses primarily for replacement of company infrastructure plus some late year program-related purchases that will take advantage of the immediate expensing provisions of the tax code.

As mentioned earlier, we announced this morning the approval from our board for a share repurchase authorization of up to 20 million shares. Beyond the dividend, we expect to be in the market from time to time to return capital to our shareholders through share repurchase as well.

We booked $10 billion of net awards in the backlog during the year for a consolidated book-to-bill of 1.0. We exited the year with $17.5 billion in backlog and a pipeline of greater than 10x our revenue run rate. $24 billion of programs in our pipeline have already been submitted for consideration by our customers.

Now for some commentary specific to our fourth quarter results. Revenues of $2.5 billion in the quarter declined 2.3% compared to the prior year. We saw a direct correlation between the revenue declines on our cost-plus programs and the lower cost enabled by our integration-related cost synergy capture.

While in some cases we were able to offset this impact by driving greater scope with some of our customers that benefited from these lower prices, this headwind was a key contributor to the year-over-year revenue decline. We expect these headwinds to notably diminish in 2018 due to a more stable cost structure.

This in conjunction with our existing backlog, IDIQ breadth, and the $24 billion of submitted proposals on which we are awaiting decision give us confidence in our expectation for growth in 2018.

Non-GAAP adjusted EBITDA margin of 9.7% came in as expected, up 26 basis points compared to the prior year driven by the impact of cost reduction activities and strong program performance.

Net bookings of $2.3 billion in the quarter resulted in a book-to-bill of 0.9, the highest level that we've seen in several years for this seasonally soft quarter reflecting improved win rates across a broader array of submitted proposals.

Cash flow from operations in the quarter of $164 million was better than expected, as a higher level of advance payments more than offset a higher level of DSO than anticipated ending the year at 66 days.

Despite our scale, we occasionally do experience some volatility around our DSO level driven by specific customer payment activity on a small number of large programs.

While the DSO level will ultimately reflect some of these timing items, we remain intensely focused on delivering cash flow from operations at or above our guided levels by optimizing the efficiency of our billings and collection processes.

We reached a significant milestone in this area last month with the successful migration of the legacy IS&GS financial systems over to the Leidos accounting and billing system.

We've mentioned this to you in the past as being the final systems migration planned from the transaction and instrumental in delivering the final material tranche of the remaining cost synergy target. So far, the effects of the cutover have been as expected, and we'll talk more about this shortly during my guidance remarks.

The tax rate on non-GAAP net income for the quarter came in slightly lower than expected at 32.5% bringing our full year rate to just under 34%. Going forward, as indicated earlier, we will benefit from a lower rate here due to the Tax Act.

Given its 2017 enactment date, we recognize the net benefit of $115 million to our fourth quarter GAAP net income, primarily resulting from the revaluation of deferred tax liabilities at the lower rate. Note that we have excluded this one-time benefit from our non-GAAP results.

Partially offsetting this benefit and also excluded from non-GAAP results was an impairment charge of $33 million related to the restructuring of an outstanding promissory note receivable on assets disposed of in 2015.

As in other quarters, we also exclude the impact of amortization of intangibles as well as transaction and restructuring expenses from our non-GAAP results. I'd like to now provide some highlights of our segment results in the quarter before discussing our outlook. Revenues in our Defense Solutions segment declined 4% year-over-year.

This segment was the most impacted by the revenue headwind from the lower cost structure discussed earlier, as it has the highest concentration of cost-plus contracts. In addition, the quarter's results reflect the wind down of some programs from earlier in the year as well as the delay in the timing of material purchases on one program.

Despite the year-over-year decline, we were able to increase non-GAAP operating margins by 130 basis points due to strong program performance and the lower indirect costs.

Sequentially, we did see a 2% increase in revenues in the segment, as we begin to realize the momentum from the more recent improved win rates which also helped to drive a 1.3 book-to-bill in the quarter from the segment.

Civil segment revenues were down just slightly versus the prior year period, while sequentially revenues grew approximately 2% driven by broad-based strength across our portfolio of programs. Non-GAAP operating margins increased 45 basis points from the prior year period due to continued strong program performance and lower indirect costs.

Health segment revenues were essentially flat versus the prior year period, as growth in certain programs offset expected declines in others. The 5% sequential revenue decline in this segment reflects the expected reduced volume on a couple of contracts which we have discussed for some time now.

This was also manifested in lower margins versus the prior year period. We expect this trend to continue throughout the next couple of quarters stabilizing in the second half of 2018. However, we are focused on offsetting this headwind through growth in other programs. Now, as we look ahead to 2018, we're already off to a solid start.

We have a lean cost structure and increasingly powerful business development organization, a broad portfolio of technical capabilities and IDIQ vehicles, and over 31,000 of the most talented and committed employees in the industry.

We are executing against the largest pipeline that we've had since the acquisition closed in 2016 and we're optimistic that the two-year budget agreement will allow for a more expeditious award process against this pipeline. These factors give us confidence in our view for 2018 and beyond. And with that, I'll turn now to guidance.

We expect 2018 revenue in the range of $10.25 billion to $10.65 billion, reflecting a 3% year-over-year growth at the midpoint. We expect the growth to be more back-end loaded, driven by the effects of the budgetary environment on the procurement process.

Qualitatively, given the strength of our pipeline, our improved win rates, and the stronger budget numbers approved for the next couple of years, we expect to see our top line growth increase further in the out years.

We expect 2018 adjusted EBITDA margin in the range of 10.1% to 10.4% reflecting a slight uptick in investments to drive growth as we discussed earlier. Our expectation for 2018 non-GAAP earnings per share is in the range of $4.15 to $4.50 a share.

Finally, cash flow from operations is expected to be at or above $675 million reflecting the net benefit of the lower tax rate, offset by an increased level of working capital required to support our revenue growth.

We do expect the financial systems transition mentioned earlier to further exacerbate the seasonally low Q1 cash profile due to billing transitions with our customers. However, we do expect this effect to reverse throughout Q2 and Q3.

This expected Q1 dip in our cash balance is the primary reason that we held a higher level of cash exiting the year at $390 million compared to our targeted cash level of $200 million to $300 million. A few other notes related to our guidance. First, net interest expense for 2018 is anticipated to be about $135 million.

Following the enactment of the Tax Act and the revised treatment of CapEx as discussed earlier, we now expect CapEx for 2018 to be consistent with 2017 spending levels at approximately $80 million. And finally, we expect our non-GAAP effective tax rate for the year to be in the range of 23% to 24%.

And with that, I'll stop and turn it over to Rob to take some questions..

Thank you. At this time, we will be conducting a question-and-answer session. To allow as many as possible to ask questions, please ask one primary question and one follow-up question. Our first question comes from line of Cai von Rumohr with Cowen and Company. Please proceed with your questions..

Yes. Thanks so much. Good quarter.

So first on the bookings, this year I recall you don't have any of your top 10 contracts up for re-compete, so you should have a fairly light re-compete year, and with the bookings vigor you're seeing, are you seeing any reversal of the situation you had last year when you just – you get three to six months' extension so that we're really going to see this bow wave of potential awards come through?.

Cai, by the way, thanks for the comment. That's what we're seeing and that's what we're thinking, okay? Now, where we sit today, we've got appropriations bills, but we're still facing an omnibus decision on the 23rd of March.

Our assumption going forward is that we will get the specific budgets cleared up in the omnibus that will get passed on the 23rd.

That will free up for the remainder of the fiscal year the acquisition and procurement process in both Defense and Civil, and we'll see a lot of programs, frankly, quite a few new starts, that have sort of been hung up in the continuous CR cycle brakeless (30:20)..

Terrific.

And based on your comments about the first quarter, would it be fair to assume that we should see a book-to-bill definitely above 1 in the first quarter and hopefully for the year?.

We know – Cai, I appreciate the question and you kind of know the answer. We don't guide on it quarter-by-quarter. And let me just simply say and why I included those comments, we are pleased with what we have seen since the first of the year.

We cleaned up a protest or two, which happened in 2017, frankly, in our favor and we've seen some nice awards already in January. And that's really as specific as I can be..

Thank you..

Our next question comes from the line of Ed Caso with Wells Fargo. Please proceed with your questions..

Hi. Good morning. It's actually Rick Eskelsen on for Ed. Question, if I can, on the revenue synergies that you've seen and expect to see from the IS&GS transaction. You've done an impressive job on the cost synergies side.

And I know the revenue was always going to take longer, but what have you seen and how is that contributing to the higher win rate?.

Hi. Good morning. This is Jim. Thanks for the question.

The way we have defined revenue synergies in the past, and I think that the way you might recall us talking about it at Investor Day, is things that would not have shown up in the pipeline or significantly improved win rates on things that we compare to kind of the steady-state case before the acquisition.

The numbers that we previewed then, we have actually done better than what that plan was. And in fact, earlier in 2017, I think that we did talk about a couple of significant contract awards that we had received in the DOD space that were not in the bid pipeline from either business.

So things started popping up a little bit earlier than we expected and we're pleased with where revenue synergies have gone so far..

Thanks. And then just two numbers questions, if you can. Can you quantify what your win rates are now? You talked about them being better. Can you give us a sense of what they are? And can you also quantify how big that cost-plus revenue headwind that's going away was in 2017? Thank you..

Yeah. So we're not in the habit of disclosing what our win rates are, but we've analyzed this, as you might expect, in a whole number of different ways. And any way we've looked at it, we're very pleased with an improvement in the win rate compared to what it was at the time that we put the deal together.

And that really we owe to two or three primary factors. First, the cost structure is significantly leaner than it was during the period leading up to closing the transaction.

And then secondly, having some different business development processes – new business development processes and some new people involved, as you can imagine, it does take more than a couple of quarters for you to start to see the benefit of that.

And now, we're seeing that in both the win rates that we're seeing as well as the size of the pipeline that we're executing against. And then, in terms of the revenue headwind, we talked about a $350 million cumulative annualized impact of cost synergies.

And actually, the revenue headwind on an annual basis is a little bit over half of that $350 million..

Thank you very much..

Sure..

The next question comes from the line of Noah Poponak with Goldman Sachs. Please proceed with your questions..

Hey. Good morning, everyone..

Good morning, Noah..

Hey, good morning..

Hey, just to follow-up on that revenue impact from less cost-plus revenue from the cost synergies.

The half of the $350 million, on an annualized basis, did that mostly come in the fourth quarter because I just don't remember you guys talking about that before? And then also, did I hear you correctly that there was also, as a totally separate item, just some contract timing slippage out of the fourth quarter?.

The first question, Noah, the impact on that roughly 1/2 of $350 million, that actually had been felt throughout the year. We hadn't been talking about it primarily because when we stepped back and took a look at our analysis of the year-over-year for the full year, it was clearly something we couldn't ignore and we wanted to get it to you guys..

And Noah, of course, that headwind is completely aligned with the rate of cost savings.

Because we got off the TSA agreement in October because of the great work that our CAO and Jim and his team has done on our supplier management system and our accounting system, some of those cost reduction synergy benefits did occur in the second half of 2017 as we have talked about in our call..

Okay. And was there also additionally a slippage of anything? It sounded like you're alluding to that in your prepared remarks. Just wanted to understand how big that was if that happened..

There was a little bit. I think that when we think about – I mean, overall, I think we felt pretty good about the Q4 bookings number compared to a typical Q4. We would have expected a little bit less, but we were able to pull some things in, actually, in the last month of the quarter. So we felt pretty good about that.

The other thing that's probably notable relative to bookings, one thing that was a bit of a headwind for us in the full year number is that the amount of backlog that we had to adjust because of the change in rates.

Because customers were going to take the savings that we were offering them on contracts in place, it required us to take that adjustment against the gross bookings number for the year. And when we look at the gross bookings number, new contract awards, we feel pretty good about that and it gives us some good momentum going into 2018..

Okay. And then just last thing, Jim, on working capital, am I hearing you correctly that you're saying you – in your 2018 cash flow outlook, you're embedding a total working capital headwind year-over-year.

Is that correct?.

Yeah. And really, the headwind isn't DSO-focused as much it is that – with our view right now, the visibility we have in our revenue picture says that we're going to have year-over-year growth and sequential growth in the back end of the year. When you hold DSO constant, it does require you to put some of your cash into accounts receivable.

And that's where that kind of headwind comes from..

Do you not have the large tailwind from the reversal of the bill that was specific to the novation process from the IS&GS integration?.

That's a great question, but we really saw that in Q3 and Q4. So if you take a look at where cash flow has been in 2017, the back end was a little bit stronger than we have previously indicated and guided, and that came from the novation process playing out..

Okay. Okay, thanks very much guys..

Right. Thank you..

Our next question comes from the line of Jon Raviv with Citigroup. Please proceed with your questions..

Hey, good morning, everyone..

Good morning..

Roger, could you add a little more perspective on what you mentioned in terms of the potential to accelerate growth in the out years, just give us a sense for what you might be seeing? And then how does that interact with the long-term margin target which we're already running above? I guess, at the end of the day, the question is, do you see earnings growth coming mostly from sales or margin or both going forward?.

Okay. Good.

A couple of great questions, and as we have tried to say in the past few calls, those things are completely intertwined, right? And you all often ask, from an investment standpoint, which would we prefer? And I think our answer has consistently been, as it was on Investor Day, is that we want to operate that business in double-digit margins and we were fortunate that we achieved that, frankly, earlier than we had predicted in August of 2016.

And I think we had been actually pretty clear that once we got there, that we would try to maintain that margin rate, plus or minus quarter to quarter, but we would take funds and use it to invest in growth. And quarter-by-quarter, we'll be a little high, a little low.

We want to continue, as I think I said in my prepared comments, in that low-double digit, but we want to invest in technology new business funds, capital where it's appropriate and it fuels our competitiveness in programs going forward.

Coming back to sort of the budget and the tailwind that we see, our early read of the appropriations bill and what we've seen already in the 2019, if you will, skinny budgets that are out and being analyzed is, there is a nice balance between capital acquisition of our customers and improvement in solutions and services.

So, on one hand, we have a customer who needs to buy platforms, ships and tanks, and airplanes, but they also have mission-capable rates and readiness and soldier welfare, for instance, that have also become important, and we actually think we benefit from both, but we're very pleased that we see additional money for the VA, for instance, which we think will allow them to move forward more aggressively on their updating of their VistA electronic healthcare records program, a program we hope to participate in with our partners.

And so there's just a lot of good things for us in the way the BBA – the Bipartisan Budget Act actually came out.

One last point I'll make not to get too long of an answer, but many people expected to see the increase in defense spending, but because of how the bill was actually constructed, they had to raise the budget caps on civil, government as well as defense.

And so where it appeared maybe a quarter ago, it was going to be a trade between the defense part of the business and the civil part of our business, and as you all know, we're relatively balanced in our exposure to both markets. We now sit here today realizing we're going to get a top line increase on the defense side.

But what maybe wasn't completely understood is because we wanted to get the sequester caps raised, that the civil side of government gets a proportionally increase in their top line as well. That's really going to help a lot of our civil agencies, FAA and organizations like that for which we have a significant business..

Got it. Thanks for that comprehensive answer. I'll hop back in the queue and give some other folks the change..

Okay. Great. Thanks, Jon..

Our next question comes from the line of Krishna Sinha with Vertical Research. Please proceed with your questions..

Hi. Thanks for taking the questions. So, just a quick housekeeping one.

I don't know if you mentioned this in the prepared remarks, but what was the increase in corporate expense in the quarter?.

The increase – well, we had a pretty significant – I'm not sure which one you're talking about, but there was a pretty significant increase in the corporate numbers related to – we took an impairment charge on a note receivable. That was primarily because of the underlying collateral related to that has been impaired.

So we needed to take that charge and that's related to some assets that we disposed of a couple of years ago..

Okay..

That was the single biggest driver there..

Okay. And then just to elaborate on your earlier comments around the DSOs, obviously they're lumpy, so I don't expect much clarity on just individual quarters, but you have talked about an ability to reduce the DSOs by, I think, something like five to seven days to get it back down into the low 60s.

Is that still the goal and can you outline a timeline for that?.

Yeah. So our goal is always to continue to extract and get non-cash working capital off the balance sheet as a result of improving our billing processes, and today we've cut over to a single billing platform that we run the whole business on and it's one that our customers are very familiar with.

I would say that we aspire to numbers that are significant improvements over even what we've guided to, but at this point, the number that we're guiding to is the one that we are confident as being pretty solid in terms of where DSO is going to the end of the year.

The way I think that we look to be able to continue driving that better into the future is coming up and actually putting all of our major programs on singular billing processes that, as we look to how it was being done in the legacy IS&GS Business, they were really done program-by-program. They were all done differently.

And we have, I think, a significant opportunity to both improve the speed at which we get bills out and therefore get them collected and also the cost at which we do those billing processes. So I think that the answer is I think that there is opportunity. It's just a question of when..

Okay. And then one final one. You talked about $24 billion in proposals awaiting decision. I guess one question there is does that include any factored VA contract or even the NGEN contract that I know you announced your team for recently? And then just a broader question. There are some sizable contract opportunities out there.

It sounds like the government is consolidating contracts to have larger contracts. I know GD certainly cited that as a reason to buy CSRA.

So can you just talk about what you're seeing in terms of government prioritization on making contracts larger and awarding them to larger fed IT companies such as yourself?.

Let me take part of that and I'll give part of that to Jim. By the way, a lot of questions in there. First of all, is the Navy Next-Gen or the VA EHR/EMR in the $24 billion? Neither of those programs have gone to the bid stage, so they wouldn't be in what we track as our submits. They are in our pipeline.

They only go too far off into pipeline discussions, but we have obviously a pipeline that we maintain of prospective bids and our pipeline number is significantly larger than the $24 billion.

And then you had sort of a general question about do we see customers opting for larger companies? Are they aggregating more? First, let me say I don't think the trend is significantly different than it has been in the past and I think all customers kind of go through a cycle.

If they start out and maybe go with smaller contractors, they find the administration cost of that can be expensive. We in the lifecycle of any kind of a technology with a customer at some point they do start aggregating contracts because it's simpler for them to execute.

But at any – one of our customers, any one of our – those agencies within the customers, we see all kinds of behaviors. We do see some contracts being consolidated and they do look for larger firms to compete against those. But many of the customers are looking for innovation and they write smaller contracts and they could take more risk with those.

And I think it's important for a company like Leidos at our size to be able to, yes indeed, compete on the large programs and have the people and the cost structure to do that, but also to invest in R&D and innovation, and to do things like watching an information assurance and artificial intelligence and machine learning, all those kind of things, they will be the large programs in the future.

And our thesis is that we can provide a broader spectrum of solutions to our customers with a company the size of Leidos.

And, Jim, do you want to add...?.

Yeah.

Just the only other thing I think is worth adding to that, Krishna, is that while many contracts are getting larger, there is an increasing tendency, and we talked about this before, toward moving away from the big, full and open contracts to IDIQ-type contracts that allow the procurement process to be on the government side and quite honestly, with the contractors, more efficient.

And what that means for us is that we will participate in a big IDIQ or even a single award IDIQ and then we get task orders that we add to backlog as the task orders are received rather than putting a big contract value into backlog..

Our next question is from the line of Rob Spingarn with Credit Suisse. Please proceed with your questions..

Good morning..

Good morning..

Hey, Rob..

So, Roger, on the back of that, consolidation was brought up.

What do you make of the latest consolidation efforts in the industry and the fact that there will now be two of you roughly the same size out there?.

Yeah. Let's see, Rob. Not surprised, right. I think we have been pretty transparent all along that we expected further consolidation in the industry. We have always said – you say there are two of us our size, and I think we have tried to indicate – depending upon how you define the industry, there are already big players. There's AECOM and IBM and DXC.

And so there's – depending upon where we're bidding, we see big companies and small companies. Our deal thesis as we put forward was there are benefits to being bigger, the investments you can make, the strength of your balance sheet, and what we view the latest consolidations is other people must believe that as well.

And as I think we've said on prior calls, Rob, we don't think it's over, right. I think there's opportunity for more consolidation because of the value capture, the synergies we're able to create when you put two smaller entities together.

Not to be said there won't be some very strong players who are, if you will, more nichey, who decide that being at $5 billion, for instance, is where they want to be and then that's fine with them. We look at the market differently. We made a different choice..

Okay.

And then, just on the – maybe this is for Jim, but on the revenue guide, looks like about 1% to 5%, depending on how things play out, what are the major swing factors there? And is that growth concentrated in one business segment or another? How do we think about it that way?.

Yeah. So, Rob, we're kind of trying to avoid being in the business of guiding these kind of numbers to specific segments. I would tell you that it is broad based across all of our business segments. And there really isn't any single big contract award upon which that revenue guide sits.

I think that we're confident that the number will be consistent with our guidance that's based on what our win rate trends have been and what's the size of the pipeline is against which we're executing, and the size of bids that are in evaluation with customers today..

Is it fair to say that you expect the legacy Leidos businesses to start to reaccelerate along with IS&GS, which I think was the growth engine in 2017?.

Today, they're so fully integrated that we don't even analyze and think about there being a legacy Leidos win rate or a legacy Leidos book-to-bill and a legacy IS&GS book-to-bill. The systems are managed on one accounting system and one business development system, and we have stopped looking at the business that way.

I do think that when – without looking at the numbers that way, I would say that the whole business is performing with the same kind of strength as opposed to thinking about it as legacy Leidos or legacy IS&GS..

Okay. Okay, thank you..

Thanks, Rob..

Thanks, Rob..

The next question is from the line of Greg Konrad with Jefferies. Please proceed with your questions..

Good morning. I just wanted to come at the revenue synergy question in a different way.

I mean when we look at that $24 billion bid pipeline outstanding, is there any way to quantify maybe how many of those opportunities you wouldn't have been able to bid on prior versus as the merger happened that you're able to bid on today?.

Not with any kind of precision to be honest with you, Greg.

What we can tell you, though, is that there are things that show up when Roger and I do a bid review that we can point to as saying, okay, well, this wouldn't have been something we could be executing on had it not been for either technical capabilities that we acquired in the deal or customer intimacy that we acquired in the deal.

And we're confident that the numbers are consistent with – or better than the numbers we previewed you before..

Thanks. And then just a follow-up on the cash flow number. I mean it includes $75 million cash impact of transaction and integration costs.

Just to clarify, I mean, so do those costs complete in 2018? And is there kind of any update to maybe the synergy potential versus the $350 million that you said you generated in 2017?.

Yeah. Just to make sure that, for the benefit of clarity, the number we've previewed for 2018 does include a roughly $25 million cost relative to resolution of a matter on purchase price adjustment with Lockheed Martin and we took that to the P&L because it was outside of the one-year purchase accounting window.

So, that's really 1/3 of the $75 million that you see there. There is a small amount of trailing costs that we're expecting in 2019 that is not related to systems or other integration things. It really has to do with consolidation of our real estate footprint, which is expected to end in 2019..

And just on the synergy number, I mean are any of those synergy-producing when we think about kind of the $350 million that you ended 2017 at?.

Yeah. Of the $50 million, they definitely are associated with producing not just the $350 million, but we've indicated that the run rate will go up to $400 million, and to close on that, we do have some remaining acquisition and synergy-related investments that we have to make.

That's the $50 million that relates to closing up the systems migration, there's been a significant amount of cost in the first quarter on that, and then there's also some significant investment in severance and other similar costs..

Thank you..

Thanks..

Thank you. We have time for one additional question this morning. It's coming from the line of Brian Ruttenbur with Drexel Hamilton..

Yeah. Thank you very much. Just a couple of quick housekeeping questions. So IS&GS, it is done in the first half. We shouldn't see any additional charges beyond that.

Is that correct? Is that what you mean?.

You mean additional charges related to the acquisition? I mean....

Right..

...other than what we've previewed..

That's right..

Yes, that's correct..

Okay.

And so you're 80% done right now just as – or 90% in your opinion?.

Yeah. I mean when we think about the percentage of costs that we're expecting to incur relative to acquisition and integration costs, that's a fair estimate..

Okay. And then a couple other little housekeeping.

The share count that you've assumed for 2018, have you assumed any buyback in that or any of your projection in terms of interest or cash flows?.

Our guidance assumes that the buyback at this point will take care of any kind of additional share issuances in connection with our employee benefit programs..

Okay. So you basically assume just flattish going forward.

So if you make a big purchase, that should be accretive to your guidance or move guidance from the lower to the higher?.

That is true..

Okay. Great. Thank you very much..

All right. Thank you..

Thank you. I now turn the floor back to Kelly Freeman for closing remarks..

Thanks, Rob, and thank you, all, for your participation in the call today. Have a good day..

Today's conference has concluded. Thank you for your participation. You may now disconnect your lines at this time..