Leidos Holdings, Inc. (NYSE:LDOS)
Q2 2016 Earnings Call
July 28, 2016 08:00 AM ET
Kelly Hernandez - VP, IR
Roger Krone - Chairman and CEO
Jim Reagan - CFO
Cai von Rumohr - Cowen and Company
Robert Spingarn - Credit Suisse
Bill Loomis - Stifel Nicolaus
Edward Caso - Wells Fargo Securities
Tobey Sommer - SunTrust Robinson Humphrey
Amit Singh - Jefferies
Michael French - Drexel Hamilton
Greetings and welcome to the Leidos Second Quarter 2016 Earnings Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.
I would now like to turn the conference over to Kelly P. Hernandez, Vice President of Investor Relations. Thank you, Ms. Hernandez. You may now begin.
Thank you, Rob, and good morning, everyone. I'd like to welcome you to our second quarter 2016 earnings conference call. Joining me today are Roger Krone, our Chairman and CEO; and Jim Reagan, our Chief Financial Officer; and other members of the Leidos management team.
Today, we will discuss our results for the quarter ending July 1, 2016. Roger Krone will lead off the call with comments on the market environment and our company strategies. Jim will follow with a discussion of our financial performance and our expectations for the future. After these remarks from Roger and Jim, we'll open the call for your questions.
Today's discussion contains forward-looking statements based on the environment as we currently see it and as such does include 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 provided on the Investor Relations section of our website at ir.leidos.com.
With that, I'll turn the call over to Roger Krone.
Thank you, Kelly, and thank you all for joining us this morning for our second quarter 2016 earnings conference call. Our second quarter performance was in line with our expectations. Revenue profitability and cash performed on or slightly above our expectations, which includes and expected below average level of contract write-offs in the quarter.
Our end markets are gradually improving and despite a slower pace of procurement activity from our customer for new awards, we are seeing increases in scope and the expansion in some of our existing contracts. All this giving us increased confidence in our full year outlook.
Since our last call, we’ve cleared a number of milestones related to pending transaction to combine with Lockheed Martin’s IS and GS business. At this time we have obtained all regulatory approvals both domestically and internationally, and we have also filed our final registration statement with the SEC, which was declared affective on July 11.
Our integration management office is making significant progress and preparations for a transaction close date in mid-August. We have secured all required financing for the transaction. Our debt facilities were well received and based on strong demand; we were able to secure better economics as compared to when the deal was initially launched.
These attractive rates now enable the transaction to be accretive in the first four years, as compared to our prior expectation of mutual accretion on a non-GAAP EPS basis. We are encouraged by the recently reported results from IS and GS, as well as all of the feedback we are receiving from our customers our employees, the IS and GS employees and our shareholders regarding the positive impacts expected from this transaction.
In just a few days, on August 1, we will be hosting an investor day at the New York Stock Exchange to share further updates on the transaction, introduce new members of the combined management team, as well as provide financial updates related to the combined entity going forward. The investor event will be webcast live on our website at ir.leidos.com.
From a macro perspective, we are continuing to see a modest recovery in all of our end markets. The downturn is flattened out and outlays are beginning to tick up. We expect that we will start the government fiscal year on October 1, with a continuing resolution. But that’s been evident for some time now.
What we don’t know is how long that will be in effect and this won’t be finalized until congress returns in September. However, despite this, we expect a routine start to the new fiscal year with levels of spending consistent with the budget request, so that this time we are not expecting much impact from the CR. This year there is clearly a level of uncertainty surrounding the election and potential impact on budgets; however we are certain that we are well positioned to capture an increasing share of the budget as we remain focused on solving our customers’ most challenging mission-related problems.
On to the quarter, consolidated revenue of 1.3 billion was up 2.5% from the prior year or up 9% when normalized for revenue from our heavy construction divestiture which closed during the quarter. We are encouraged by the growth in the quarter, particularly as it was driven by organic growth in both of our business segments.
We did have a couple of notables below the line during the quarter which offset each other. One positive related to lower taxes associated with updated accounting standards, and one negative related to the strengthening of the US dollar against the pound sterling, driven by the British decision to leave the European Union.
Jim will provide details on both of these in a few minutes. Our GAAP earnings per share from continuing operations increased to $0.55 from $0.50, largely reflecting the impairment charges recognized in the prior year period. Non-GAAP diluted earnings per share was $0.68 in the quarter compared to $0.77 in the prior year. The decline is driven by an expected lower level of profitability in our National Security segment compared to the prior year, as I mentioned earlier.
During the quarter, we generated 72 million in cash from operating activity, bringing our cash balance at the end of the quarter to $670 million. Our book-to-bill on a consolidated basis was 0.74 for the quarter and 0.84 on a year-to-date basis. Bookings in the quarter were driven by strength in the health and infrastructure sector. We continue to experience stall procurement activity with many of our government customers causing delays in award decision.
I am pleased however, with our teams’ ability to engage with customers against this backdrop and offer timely solutions to their mission challenges, which has resulted in scope expansions and program extensions helping offset some of the weakness from the broader delayed decision making.
Heading in to the end of the government fiscal year, we do expect to encounter a strong quarter for bookings and awards activities as is typical for the September ending period. Overall, I’m pleased with the quarter and the progress we are making in returning the company to growth by focusing on our core competencies.
Our priorities remain on our people, our capabilities and our cost, and I firmly believe we are on the right track in all of these areas. Not just in the quarter we reported, but in what lies ahead. Before I turn the call over to Jim, I’d like to take a moment to recognize our employees for the hard work and dedication to the company and to our customers.
With that let met hand the call over to Jim Reagan, Leidos’s Chief Financial Officer for more details on the quarter and our outlook.
Thank you Roger and thanks everyone for joining us on the call today. Our second quarter results came in as expected, as Roger previewed and we have increased confidence in our full year guidance which we are revising this morning.
Consolidated revenues for the first quarter were 1.3 billion up 2.5% from prior year levels. As Roger indicated, normalizing for the sale of our heavy construction engineering business, revenue showed organic growth of 9% from the prior year period. GAAP operating income was 75 million during the quarter, up 17% from the prior years’ level, reflecting the impact of an impairment charge in the prior year period and partially offset by acquisition and integration cost incurred during the current period.
GAAP diluted earnings per share from continuing operations for the second quarter was $0.55 versus $0.50 in the prior year period. Note that the divestiture of our heavy construction engineering business did not have any material impact on earnings per share in either period. Adjusted EBITDA which is based on our non-GAAP operating income as detailed on slide 17 was 95 million during the quarter, representing a margin of 7.4% down from 107 million or 8.5% in the prior year period.
The lower level of adjusted EBITDA margin versus the prior year period was driven by timing of indirect expenses, as well as lower program fees and contract mix in our National Security sector as compared to the prior year period, offsetting improvements in our health and infrastructure sector.
As Roger previewed, we had two below the line items during the quarter, which affectively netted each other out. The first was a $0.04 positive impact driven by a lower GAAP tax rate during the quarter of 32% versus our normal tax rate of 37%. This lower tax rate was due to our early adoption of updated accounting standards related to accounting for share based compensation. This change results in a lower tax rate not just for the quarter, but also retroactively to the first quarter resulting in a $0.05 increase to our prior reported Q1 non-GAAP EPS results.
The second below the line impact was a $0.04 negative effect of currency translation adjustment related to an inter-company receivable. This is a non-operating non-cash item which impacted the quarter and was the result of the significant movement in the value of the pound sterling versus the US dollar, driven by the Brexit referendum. As I said, these two effects offset each other during the quarter.
Q2 non-GAAP diluted EPS from continuing operations was $0.68 per share down from $0.77 in the prior year as detailed on slide 15 and 17 of the investor presentation on our website. Note that non-GAAP diluted EPS for the quarter excludes and integration cost of 15 million associated with our pending transaction with IS and GS. Non-GAAP diluted EPS also excludes amortization of acquired intangibles and other items as detailed on slide 17 of the investor presentation.
Operating cash flow generated by continuing operations was largely in line with our expectations at 72 million, which reflects payments associated with the acquisition and integration costs previously mentioned.
We ended the quarter at 65 day sales outstanding, flat sequentially as expected when normalized for the sale of the heavy construction engineering business. We exited the quarter with a sizeable cash balance of 670 million and we are well positioned for the expected closing of the IS and GS transaction later this quarter.
Shifting to our business development results, the pace of bookings was impacted during the quarter by the delays in procurement activity at our government customers as Roger indicated. However, in Q2 our business development teams experienced an uptick in RFP activity and we realized a significant sequential increase in debt submissions. Second quarter net bookings were 951 million reflecting a book-to-bill of 0.74.
During the quarter, we made two adjustments to our backlog, a 177 million reduction to our international backlog to reflect the strengthening of the US dollar versus the pound sterling, as well as a $125 million reduction to remove the backlog associated with our heavy construction engineering business which was divested.
The value of bids outstanding at the end of the second quarter was 12.8 billion, up 8% sequentially, reflecting both a sequential increase in bid submitted in Q2 as well as the delays in awards in the quarter.
Let me now turn to our sector results for the second quarter. First, in our National Security Solutions sector or NSS revenues increased 4% year-over-year to 915 million, driven by the ramp up in our UK LCST program. Operating income in NSS in the quarter declined from a year ago period to 61 million or 6.7% margin.
The lower level of profitability is due to lower programing fees and contract mix when compared to the prior year period. NSS bookings for the quarter were 520 million for a book-to-bill of 0.6 and 0.8 on the year-to-date basis. We anticipate a higher level of bookings in Q3 due to several anticipated award decisions, as well as typical seasonality at the end of the government fiscal year.
Now on to health and infrastructure or HIS. HIS revenues for the second quarter were 373 million a decline of 1.6% from the prior year. However when normalized for the sale of the Heavy Construction Engineering business, revenues in HIS grew 23% organically. This strong revenue growth was broad based, with improvement in the majority of our operations within the health and infrastructure sector, most notably, within our Defense Health Program.
Q2 operating margin for the sector was 10.5%, reflecting a strong contribution of our Defense Health Program as well as improvement in our commercial health operations. Bookings for the quarter and HIS were 431 million resulting in a book-to-bill of 1.2 for the quarter and 0.9 on a year-to-date basis.
A strong book-to-bill is predominantly a result of contract orders and modifications including the Hawaii Energy Efficiency Program and the Defense Health Agency’s GENESIS program.
On to our corporate sector, we realized net expenses of 25 million during the quarter. This includes approximately 15 million of transaction and integration cost associated with the proposed transaction which is excluded from our non-GAAP results as stated earlier. Excluding these transaction related expenses which we expect to incur for some time, corporate sector expenses were within the typical quarterly range.
Now, moving on to guidance; with half of the year behind us and a successful close of the sale of our Heavy Construction Engineering business, we are now narrowing our 2016 revenue range to 5.1 billion to 5.2 billion from 5.1 billion to 5.3 billion. Note that our initial revenue guidance issued at the beginning of the year included approximately 200 million of revenue for the Heavy Construction Engineering business. Only 100 million of this was realized prior to the closing of the sales transaction.
For non-GAAP diluted earnings per share, we are increasing the range by $0.10 to 285 to 305, reflecting the impact of our first half results from the lower tax rate detailed earlier, as well as our increased confidence in the full year results. We expect our tax rate excluding any impact from our pending IS and GS transaction would be approximately 36% for the second half of the year.
Finally, for cash flow from operations, we continue to expect to be at or above 275 million. As a reminder, all guidance metrics are provided on a basis to exclude any impact from the proposed transaction with IS and GS.
In conclusion, we are pleased with the momentum of our business and the strong organic growth in both of segments. We remain resolutely focused on all aspects of Leidos platform including people, the capabilities in cost in order to address the needs of our customers and to grow our business.
Looking ahead, as we move towards a successful close of our transaction with our IS and GS, we look forward to sharing more details regarding our view of the combined entity at our analyst day on August 1.
With that operator, let’s now open it up, so that we can take some questions.
[Operator Instructions] our first question comes from the line of Cai von Rumohr with Cowen and Company. Please proceed with your question.
Cai von Rumohr
So first if you could walk us through, the revenue guide came down, a 100 million of that was a designed build sale. How much do you expect the impact of Brexit to be?
Cai, this is Jim. Right now we expect the impact of Brexit on revenue to be immaterial. There is a slight downward impact, but that’s been offset by some other positive impact elsewhere in the business which give us a kind of a new cool view of those two items combined. It is probably also worth saying that there will be no impact on the profitability of the program relative to Brexit because we have done a good job of matching the revenues and costs of that program to both being the UK currency.
Cai von Rumohr
And so your margins with NSS was 6-7 I think we’re a little lower than some of us were expecting. May be walk us through some of the mix and lower fee issues and where you expect those to be for the year?
Sure. I think as we’ve said before, we still think of this business and expect this business over the longer term not just inter quarter but over the longer term there still be an 8%. When we talk about contract mix, I think we’ve said previously that UK contract has a lower than average margin and as that ramped up it has put a bit of a dampening effect on our overall margin.
I think that there is a bigger impact when you think of this year-over-year Cai, and if you go back a year, the second quarter of last year had some pretty significant program write-ups that did not occur in the second quarter of this year. Now that said, we normally see some of those upticks that happened from award fees and EAC adjustments, they typically happened in the third and first quarter of the year and so we’re still thinking about the profitability of the segment being pretty consistent with what we’ve said before.
Cai von Rumohr
And the last one, you saw some improvement in the commercial health and an uptick in security. Maybe update us or give us some color on how those businesses are doing and how they look for the second half.
Sure. In our last call I think we mentioned that we’ve made a few changes in management both at the division management level, that’s working out very well for us and we’ve also back early in the year we’ve brought in a new sales lead. We have experienced a nice uptick in sales activity in commercial health and there’s also been some margin expansion there. So we’re pleased with how things are going there and the new leadership and new product offerings that were incubating in that business we feel very good about.
Hey Cai, this is Roger, let me just add to Jim’s comment is that by exiting businesses that are not in our long term future, plain field, the heavy design build, one of the great things about that is the management team now can refocus on those businesses that are part of our core and your plain field consumed a lot of calories for us and design build as well and now that those are behind us the team has really been able to focus on the environmental business the energy business and the health business and we’ve seen a nice turnaround as a result.
Our next question is from the line of Robert Spingarn with Credit Suisse. Please proceed with your question.
I wanted to ask a couple of questions starting with the organic growth in the Health and Infrastructure segment, what you had there.
Is that your question Rob, I am sorry; you’re just asking kind of a little more color on that.
Yeah a little more color on the organic performance there. I guess you ticked the divestiture out, I just wondered if there is anything else or if it’s just a clean number and what the underlying performance is there Jim. And then I also wanted to ask about the collections that you spoke of in the release a little bit of timing on the working capital.
Sure. Let me start with the Health and Infrastructure Group, again organic growth there 23%. We said its broad based and that’s a fact. The Defense Health business, the GENESIS program which used to be known as dim sum is actually experienced some contract amendments on past quarter number one. So the volume there is a little bit higher than we might have thought six months ago.
I would also tell you that the performance of the program is in line with expectations from a margin perspective. There’s probably a tangible impact on the commercial health business from now we’re conducting one of the largest if not the largest EHR implementation that there is with the Defense Health Program and that helps give us a little of an additional swagger in the commercial health business, and the margins are expanding there nicely as well.
I would say that the engineering part of the business, it’s performing nicely, about on expectations. I think that really what we’re seeing the biggest updraft in that segment is on both commercial and the US government health business.
Well just as you’re mentioning it Jim or Roger, when will that swagger begin to convert in to some more opportunities or into some more contracts in either the commercial world or elsewhere in the government.
Well Rob I think that they really are who they are. We’d seen some expansion in the volume of the GENESIS program, we are seeing a nice uptick in the Commercial Health business as I mentioned. And this is also giving us some additional interest in the agencies such as the VA, where we already have our presence and we going to be looking at an expanded presence, and when we have our investor day on August 1, we’re going to talk a lot of more of that how our existing strength in both elements of our health business combined with the qualification that comes over from IS and GS in other elements of the health business particularly at CMS, we’re going to have a lot of conversation about what that means for the combined business.
And then I interrupted, you were trying to answer the question on the collections.
Yeah, so if you back to looking at our collection pattern, I should say our seasonality on cash flow in 2015 and even back to 2014, you will see that there was a much more significant uptick in seasonality in cash flow in Q3 and Q4. You saw it last year, we are expecting to see it again this year, maybe not to the same - if you look at our guidance number, we’re not going to have the same influx of cash in the second half of this year like we saw last year, but we’re still expecting it to have - we’re going have a nice ratio of cash from operations to net income over [1.0X].
Okay. And then just lastly, Roger what are you thinking in terms of book-to-bill for the two businesses for the year?
Slightly above 1.
In both cases?
Yeah. We’ve always been a bit seasonal with third quarter being our strongest. And as we kind of look at our pipeline and our book-to-bill that’s what we are expecting this year as well. So obviously we want to continue to grow and so we’re pushing the team for that number to be north of one.
I’ll just amplify on that with one additional point, we really did see a significant uptick in RPs we were responding to with strong qualifications in Q2 Rob. And our win rates are holding up consistent with what our plan is, and so with additional volume and holding on to the win rates and the different elements of our bid pipeline that underpins the confidence you’ve heard from me and from Roger.
Our next question is from the line of Bill Loomis with Stifel. Please proceed with your question.
A couple of things, one on - can you just fill us in UK contract where you stand there with the transition and how do you expect to see margins and profitability over the next year.
Let me talk to you a little bit about what’s going on in the contract and I’ll have Jim touch on the numbers. First, we were just there. We had our leadership team over in the UK last week and we went to Downingtown which is near Telford which is the big fulfillment center. It’s kind of like the equivalent of the DoA here, and we looked at the legacy buildings which is where the current fulfillment of commodity supply is done for the MoD and we visited what we called a new Defense Fulfillment Center think about as about a million square foot warehouse that we are building on behalf of the MoD and there’s a roof and a floor and we’re putting in roads and we will put the first material in that new warehouse in December.
So that is essentially on track given where we started the program really about a year ago. I think we actuate authority to proceed last August. So we’re really pleased with the progress we’ve already seen significant increases in efficiency and throughput by way of some things we care about like loss per day case rates and accidents and things like that are significantly down. We’ve got a great relationship with the UK customer. I’m on a strategy board and I go over four times a year and we sit down with the three star in MoD who is responsible for defense fulfillment.
So, so far everything is on track and we will be moving material from their legacy warehouse complex to their new starting in December and by this time next summer we should have the warehouse fully stocked, we’ll have our new software installed and we’ll be driving efficiencies in to the program.
With that I’ll let Jim talk about where we are in the numbers.
Sure. Relative to the contract performances Roger mentioned Bill the contracts’ performing well, margin generation is as expected for the current phase of the contract which has a fairly significant level of pass-through cost which deny of - because they are direct pass-throughs they don’t have a markup on them. But we still have to book the revenue on it, right.
As the contract moves in to the next phase and we’re actually beginning to increase the volume of what we’re buying on behalf of the customer, that’s when the opportunities to earn some incentive fees relative to what we are saving for the customer, we are able to start to recognize those at higher levels which we are expecting to really kick in more next year than they are this year.
And then the last thing that I would say is that, our strategy for the bidding and standup of this contract is make decent margin on this contract and then look to expand our presence in this kind of work, not just in the UK but elsewhere, and so we’re viewing this as being a great place to plant the flag for commodities and logistic services in that part of the world and so far this is a very referenceable customer and we’re performing well and we’re meeting our financial objectives.
I would just add to that very quickly Jim and Bill as in discussions we have with the UK customer, again because I think of the performance that our team has demonstrated, they are contemplating could they add more classes of commodities to our contract and we hope that that will eventually happen. We’ve actually told them we’d like to get the warehouse complete and get our new software installed and get our systems up and running. But we think there is opportunity and relatively near term to add what we would call over in the US, additional classes of spares to the contract which would allow us to expand the topline and therefore the bottom line.
Okay, great. And just one final one, Jim what was the ending rate and all the cost of financing for the transaction, where did you end up with?
Right now the new financing is coming at an average just a hair over 3%. So there’s two things that have happened since we previewed the financing back in January. One, as we’ve negotiated the final financing, we negotiated better credit spreads than we had originally modeled and then the second thing is that, we had a conservative view of meaning a higher view of where the LIBOR base rate was going to be, and those upticks haven’t happened.
And the last point that I would make is that we’re now modeling and expecting to lock in a significant part of the new debt at a fixed rate using derivatives that are priced very attractively in the market today. So we’re looking at a strategy that takes a lot of risk up up-drafting floating rates out, but also takes advantage of a very favorable interest rate and swap market today.
Okay. So for us using including all the fee, amortizations and other costs in there, we should model what like a 3.2 or a 3.3 in our GAAP models.
Yeah for the incremental debt I would call it maybe about a 3.2, 3.1. And we’ll have more to talk about that on the 1 of August Bill.
Our next question is from the line of Edward Caso with Wells Fargo Securities. Please proceed with your question.
It’s from Wells Fargo Securities actually. Can you talk about pricing in the market particularly what the clients are doing regarding cost plus fixed price, time and materials, how that shift is going? Are you seeing any residual hanging on to sort of low price technically acceptable? Any thoughts on that front. Thank you.
Well you know Ed, I think we’ve been saying for a couple of quarters that we have noticed the pendulum starting to swing away from LPTA, and I would comment, I think we still see it swinging, but I would also play-out that there are still some pockets of very, very aggressive lowest bidder cost shootouts that we see in the market place. And we said this before, whether it’s a declared LPTA or an it’s a best value, price is always a factor in procurement.
And one of the reasons that we are so thrilled about the IS and GS merger is what we think it can do for us relative to reducing our [REPO] rates and being able to spread our corporate office cost over a larger direct labor base, because every customer we’ve got, they’ve got budget problems at their end, whether you’re a hospital or you’re in the IC or you’re an investor owned utility, and everybody has some sensitivity to price.
We are seeing agencies that were almost exclusively LPTA having a better mix of LPTA and cost plus and best value, but we think for the long haul, cost, price and affordability is going to be a major factor. So we’re excited about the merger and the consolidation what we think we can do for our, what we call our [RAP] rates.
Can you remind us on the GENESIS contract is there a large pass-through component and when does that related to Cerner and when does that kick in?
Yeah, there is - in the early phases of the contract, Ed there are some licensed purchases. There are some equipment purchases, there is an element of additional work that our large software partner is going to have, and then later in the contract there is also some pass-through of sub-contract work on change management and the actual training and implementation work done in the care facilities.
All of those are a part of the cost model on which fee is borne. So we are expecting a relatively consistent - on this contract in particular a relatively consistent [product] margin through the life of the contract. And so that said, there are some significant pass-through elements, different kinds of pass-through early in the contract compared to later in the contract. But a contract of this size, you’re going to need a lot of partners to do the different elements of the statement of work.
And last question, can you just clarify for us on the net award activity in the quarter, the reported number and the constant currency number on a dollar basis?
Sure Ed. The point of using constant currency is to ensure that we have visibility on the performance of bookings in todays’ dollar versus revenue in today’s dollars. And to the extent that there is a booking in a prior year that the value which has been impacted by changes in exchange rates we isolate that and that’s the 177 million that I alluded to.
So, as we’re looking to show that the activity of today’s awards are growing backlog that’s why we calculate book-to-bill on a constant currency basis excluding the upward or downward shifts in backlog because of currency issues.
Yeah and Bill I’m sure you realize that we have - our program in the UK is a very long term program and therefore it’s a nice numbering backlog, and any small change in the pound sterling here has sort of a whipsaw affect. And we think it’s important for you all to understand the effect of the movement in the pound sterling, which one might argue overtime is likely to go both up and down and rather than try to explain how we lost a 177 million backlog due to performance, we’re going to make sure that there is strong visibility that that’s a pounds sterling backlog that’s adjusted due to a currency change.
Our next question is from the line of Toby Summer with SunTrust. Please proceed with your question.
Along those same lines in the UK, I know its early days, but could you comment about Brexit in kind of the longer term opportunities in the UK to extend your business.
Yeah, I think we can talk a little bit. Again when we were over in the UK last week, we met with customers and government officials and think tanks. But I don’t report to be the expert on Brexit, and when I do get a change to do is to talk to a series of people thought they were.
And I think the first answer is, I’m not sure everybody really understands what the long term effect will be. I think some trends that we walked away with is, there are going to be more borders than there were, and we’re in the airport security, border security business, so we like that.
I think the relationship between the US and the UK is going to be one that continues to be strong, and I think that bodes well for us in both ways and our work in the UK is done with mostly UK nationals. So we have a very few ex-pats. We tend to take a couple of dozen people over and get a program started. But because of the type of work we do, very people driven, we hire the majority of our folks locally and do work in country.
Don’t think of us as an exporter, think of us as a solution provider. And so we are encouraged by the climate in the UK that we saw. They’ve got the same issues we have over here. They have defense health, national health issues, air traffic control, logistics, all the things that we have been successful here in the US, we see the market in the UK being equally as robust. And with anything I think the playing field just becomes even more leveled.
There isn’t necessarily a preference for EU and so therefore it is one of the countries that’s in the new latest model that you will set up with the country leadership and country manager, and we expect to be there for the long term and we expect to see organic growth.
Just wondering if you can give us a comment on your business in the cyber arena with US cyber command in particularly more publicly active. Thanks.
We don’t often say a whole lot, and I kind of like that posture. I think I like to say it this way is, you can read in the press, the comments that are made by the President and by Mike Rogers and others about what they are doing. But then I think if you understand the model of that agency is, they depend on our contractor base to provide tremendous amount of support and we like to support our customers and we bend over backwards to provide them the capabilities they need to do their job.
And so if you perceive there is a heightened level of activity coming out of those agencies then that should be a positive development for all of the contractors who are supporting us putting them on a day to day basis and its part of our portfolio. I think it’s a role that we’re are very proud of and frankly we are very pleased that customers like that call on like us to provide them people, analytical support through our products and services.
Was it additive to grow in the National Security Solution segment?
That’s a precise question, I’m looking to Jim to say, quarter-over-quarter or year-over-year. I think we would say this way, it continues to be a strong part of our portfolio, and we’d expect it to continue to be a strong part of our portfolio over the long haul. And a specific number I’ll let Jim try to answer that one. I’m not sure I have quite that much insight.
I think Toby it’s safe to say that we do a very significant amount of cyber and cyber related work for our customers and the details around that, I think they probably prefer we not get in to too much of it. I would tell you also that, we consider that business to be very strong, very successful with plenty of historic and future growth ahead of it. And we’re just not in the habit of commenting on individual contracts or individual operation results within the quarter. So obviously we did that.
Last question from me, could you comment on the opportunity at the VA and how you think that might develop over kind of a mid to long term. Thanks.
Let me talk a little bit and then Jim can add. We were added to the T4 IDIQ in the period, which is exciting, but I actually think that Lockheed had a T4 as well. So it’s one of those where we think we both are going have a T4. Our Leidos business in the VA has been aspirational. The Lockheed business at the VA is more significant, and as much as I would love to be able to give you a complete [swoop] in its rundown of the Lockheed business at the VA, it’s a little premature for me to do that.
But I know over the long haul Lockheed has been very, very successful in a couple of aspects, run through an organization called QTC through an organization that’s called Solutions Made Simple that they have and some of their base contracts. And we’re just looking forward to getting our defense, military government health teams together and start to think about our strategy and our growth plans going forward.
Our next question is from the line of Amit Singh with Jefferies. Please proceed with your question.
Just quickly on the taxes, in the first half you got around $0.09 benefit from the tax adjustments. So now based on your new full year tax rate assumption what is the EPS benefit in the second half versus what were you expecting before?
Yeah, it will be much smaller. So think of it as being a 1 percentage point downtick in our effective tax rate in the second half of the year Amit.
And then on the topline guidance, if you could talk about the guidance is lowered but when you did your first quarter call at the end of April was this divestiture already baked in at that point or this is after that, and also if you could talk about the EPS impact from the divestiture.
What I would you of is it, at the beginning of the year our guidance included an assumption of 200 million of revenue for the designed build business it’s been divested. And as you recall, we had a 5.1 billion to 5.3 billion revenue range at the beginning of the year. When we announced the divestiture, we did not at that time reduce our revenue guidance range because we felt that even after the divestiture we were going to fall squarely in that band.
And now that the divestiture is done and we’re half way through the year, we thought it was appropriate to narrow the range and taking a 100 million out of our model and then having a few upticks on other areas allowed us to come squarely at a new guidance number that we just announced of 5.1 to 5.2. So I think that answers your question on the topline.
On the bottom line the exclusion of that business taking that out has no impact on the prior year or current year EPS assumption because after absorption of indirect cost that business didn’t have a material profit impact for us. The one thing I would remind you of though is that when you take the prior year revenue out of the health and infrastructure business, our second quarter organic growth rate for that business is about 23%.
And just one last one on the LCST and then some contract, is there a way to tell us like how much of that contract is sort of fixed price and what percent of that contract is sort of fixed price cost plus. What is the sort of contract type mix of those contracts?
Both of those contracts are pretty complex and we’re not in a habit of getting in to granular detail about that. But both of those contracts we have elements of fixed price, elements of cost type, elements of award fee and I think that it is safe to say that those mix changes - as I mentioned earlier in the call, the mix changes in scope and contract type on different elements of the task for the UK contract actually gives us a little more profit margin and profit margin upside later in the contract. It should be relatively consistent on a margin basis over the life of the DHA GENESIS contract.
Our next question is from the line of Michael French with Drexel Hamilton. Please proceed with your question.
Congratulations on the performance and more importantly securing the financing for the deal on favorable terms. Roger unfortunately (inaudible) it does look like we’re going to be dealing with the CR for FY’17. There are very few legislative days left before the start of the fiscal year, and there’s lots of work to be done by the (inaudible) congress.
The question I have is your comment that you don’t expect much impact to the business, were you talking about Leidos or the combined Leidos and IS and GS. Or in other words, does IS and GS have exposure somewhere to the CR whether it’s in program starts or anything else.
Michael let met draw a very bright line. So after the deal closes I’ll be happy to talk to you about IS and GS, but until the deal closes if you have interest in IS and GS I recommend you call our Bruce Tanner and Marilyn because we just don’t have that kind of an insight in to their business and I don’t think it’s appropriate for me to comment on Lockheed.
But on our business, what typically happens under a CR, procurement activity slows, we see contract extensions, additional task orders written on IDIQs, and that has two affects which I thought we covered pretty well today is, our existing contracts are extended at their current terms, which are often may be more favorable than what you see in their re-competes.
However the book-to-bill becomes a little tepid because instead of getting a two year order you get a two month task order and where we had intended to see a new contract, we just see an extension and our book-to-bill comes down a little bit.
And kind of whether that’s a little bit of what we saw in this quarter and although we still as we said before expect to be above 1.0, an extended CR could slow down awards in the fourth quarter and first quarter of next year depending upon how long it lasts. But overall, the level of spending and the procurement activities that are in our pipeline, we don’t see them overall negatively affected by our CR. Because frankly the world has gotten quite complicated and here we see that in the press every day and as a result many of our customers are spending money as a result of again headline activity. Unfortunately that we all read daily.
So there’s work to be done and they’re finding ways to get contracts awarded and current contracts extended and so my comment was, we don’t see a long term affect from the CR this year.
Thank you. At this time, I’ll turn the floor back to Kelly Hernandez for closing remarks.
Thank you all for joining us on our earnings call today. We look forward to sharing more updates with you at our investor day on Monday, August 01. Thank you.
This concludes today’s conference. You may disconnect your lines at this time and thank you for your participation.
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