Computer Sciences Corporation - Analyst/Investor Day

| About: Computer Sciences (CSC)

Computer Sciences Corporation (NYSE:CSC)

September 10, 2012 12:30 pm ET


Steve Virostek - Director of Investor Relations

J. Michael Lawrie - Chief Executive Officer, President, Director and Chairman of Executive Committee

Paul N. Saleh - Chief Financial Officer and Vice President


George A. Price - BB&T Capital Markets, Research Division

Rod Bourgeois - Sanford C. Bernstein & Co., LLC., Research Division

Jason Kupferberg - Jefferies & Company, Inc., Research Division

Keith F. Bachman - BMO Capital Markets U.S.

Steve Virostek

Good afternoon, ladies and gentlemen, and welcome to CSC's 2012 Investor Day. We're so glad that you joined us here in New York, and we'd like to also welcome all of those who are participating via webcast. I'm Steve Virostek, the Acting Head of Investor Relations for CSC and we've got an intriguing afternoon of events here for you. I'm pleased to know that we have books available for all of you in the room, and there are slides posted to the website for those of you listing on the webcast.

Slide 2 is a reminder that we'll be making forward-looking statements during this presentation, and please keep in mind that these statements contain known and unknown risk and uncertainties, which could cause actual results to differ materially from those expressed on the webcast. A discussion of risks and uncertainties is included on our Risk Factors section of our SEC filings.

Moving to the next slide, we have the non-GAAP reconciliations. We will be referring to those non-GAAP terms, and we believe these information provides useful information to investors. In accordance with SEC rules, we've provided a reconciliation of those metrics to their respective and most directly comparable GAAP metrics. The reconciliations will be made available for download on the website, and we'll also have a copy for you as you leave the auditorium.

Finally, I'd like to remind our listeners that CSC assumes no obligation to update the information presented on the conference call, except of course as required by law. And now, I'm pleased to introduce our President and CEO, Mike Lawrie.

J. Michael Lawrie

Okay. Very good, Steve. Thank you very much. Welcome to everyone here in the auditorium at Barclays and those of you on the webcast. Thanks for taking the time today and your interest in CSC.

What we'd like to do this afternoon is I'd like to cover with you the game plan that we have now put in place to turn CSC around over the next 3 to 5 years, and this is a 3- to 5-year turnaround plan. You'll see in the books we're outlining a game plan to take us from roughly 60-some cents per share in earnings to over a $5 per share in earnings over this time frame. So what I'm going to do is cover some of those strategies and game plans at a fairly high level, and then I will ask Paul to join me on stage, and he will go through the financial model, how we get to where we are trying to get to and also to cover our emerging capital allocation program that you can expect to see from us over this turnaround time frame.

I'd like to leave with you this afternoon several key messages, and I will develop each of these messages in just a little more detail in a moment. But the first message is that CSC has a very strong global franchise that we can build off of as we go forward. There's no question that the recent financial performance of this company has not lived up to the assets that we have, both our people assets, as well as our client assets, as well as other intellectual property. We certainly recognize that underperformance. And we think over the last 3 or 4 months, we've got a reasonably good handle now on what those root causes of that misperformance has been. And as I said, we have put together a comprehensive 3- to 5-year turnaround plan. And the most important thing is, and I've said this on many of the calls that we have done over the last several months, that there's no question in our mind that the business can, in fact, be fixed. We are working on a new financial model here that we think will significantly improve shareholder value, and as I said, we'll go into that in a little more detail. As you might expect, there are some risks. We don't operate in an environment right now that's perfect. There's a fair amount of volatility. We have identified those risks. I'll share them with you today, and we factored most of them into our ongoing financial model as we go forward, and we have not been waiting for today to begin execution. So execution of what we cover today is well underway.

So let me just develop each of those key messages very briefly. First, as I said, CSC has a very strong global franchise. Over 2,500 clients operating in 70-plus countries, almost 100,000 employees. Very strong relationships with the federal government, as well as commercial clients. But what is not completely understood is most people think of CSC as primarily a technology services company, and we are. But underneath that, we have some extraordinarily strong assets, intellectual property, software assets, people skills, domain knowledge that actually drives that technology services business. And we have leading positions in the financial services industry, most notably banking, insurance and in the healthcare industry. We have leading edge, what I'll call next-generation offerings, particularly around our Cybersecurity offerings that we've developed with the federal government over the past many years, as well as next-generation IT infrastructure, what we refer to as cloud computing or as service computing. Very strong leadership position there with great domain knowledge, great people skills. So one of the great surprises coming into CSC was the extraordinary capability of the people within the company, and we have a $36 billion backlog. And as you know today, we announced another very large deal that we signed with Zurich Financial in the application space, so we continue to build that backlog as we go forward.

You can see across the industries that we operate in, financial services, healthcare, manufacturing, what we refer to as diversified and then our federal public sector, really fantastic clients on a global basis. So really, a key asset of the company are these key relationships we have. We span a global basis. So you can see here we've got a lot of resources in India. Almost 23,000 employees are in India that work every day, supporting our clients on a global basis. We've got service centers. We've got data centers. We have got call centers on a global basis. As a matter fact, this is probably an opportunity to rationalize a little bit as we go forward, but the point is a great foundation off of which we can expand and scale our business globally. You can see that about 62% of our revenues come out of North America, followed by Europe, but a very strong presence on a global basis.

And this company has got a long history of accomplishments and achievements. It was founded in 1959. Very few people realize this. It was founded as a software company -- software company. That was and is the roots of CSC, and many first with clients in the federal government and the commercial sector over that period of time. But not unlike a lot of companies that are around for 50 or 60 years, they do often get off course, and CSC got off course. And as I said, the financial performance over the last several years has not been up to the capabilities of our asset base and our people, and we think the root causes of this underperformance were fairly straightforward. One, the strategy of the company was very slow to reflect the change in the IT infrastructure business. The IT infrastructure business has been commoditizing for over 10 years now. A lot of this was brought on by less big deals, many smaller deals by clients, and it was brought on by the entrants of new lower-cost competitors, but for whatever reason, CSC doubled down in that business. Part of that was due to the way the incentives were set up, where the team was incented to drive revenue and drive total contract value. So you got almost a perfect storm where you've got a commoditizing market and you've got the entire throw away to the company, trying to drive bigger and bigger deals. We lost control, lost the discipline around our contracting, around our contracting life cycle management and around the delivery of many of our services. It wasn't that CSC didn't know how to do it. They did know how to do it. It's in binders and process manuals and its best-of-breed. But for whatever reason, the company stopped practicing what in many cases it had invented, and that caused a significant number of problems.

The company was highly fragmented. It had grown up around a series of acquisitions over that 30- or 40- or 50-year period of time. Most of those acquisitions were not adequately integrated. It was in fact a holding company. It was managed as a holding company. And with that holding company mentality and the management system around that, over time, we lost control of the financial systems. We lost control of the discipline around much of our financial systems, and that has been well chronicled in the press over the last year and culminated, of course, in SEC investigation. And this fragmentation also led to a cost structure that just was no longer competitive with the key competitors that we face day in and day out in the marketplace. So this led to an over-indexation of very high risk, capital-intensive IT infrastructure and some of significant, high-risk application deals that we had done over that period of time.

We also saw an enormous proliferation of customized contracts and customized solutions. A lot of this grew out of our heritage with the federal government, and that's okay when you're on a cost-plus basis. But when you are on a fixed price or have very strict commercial terms and conditions, that customization leads to not only higher cost, but it leads to great difficulty in execution because you are never executing anything more than once. Very, very difficult model to scale globally. And you see the financial results, the revenue flatlined, operating income declined and our free cash flow really began to dry up. And then last year, we reached the tipping point, where NHS and 30 or 40 commercial contracts all came home to roost at roughly the same period of time, and we lost over 50% of our market capitalization.

So that's all I'm going to leave to talk about the past, but it is important that you learn from the past, so you need to understand what those root cause issues are, so you don't make the same mistakes as you go forward. I'd like to thank the new team we're putting in place. We'll make a new set of mistakes, but not the same ones that were made over the last 10 years. And in the process, we frankly lost our identity. We lost what we really stood for in the marketplace, and we began to do a lot of things without a significant overarching theme around what our value proposition is. And this was one of the things that I had worried about when I came into CSC about 5 months ago, and I had done all the due diligence and looked at all the numbers and read a lot of you guys' reports, which was in itself fairly depressing. But you never know what you don't know until you are inside, and one of the first questions I asked was what makes CSC unique? And I really couldn't get a very good answer. So I went out and I talked to our biggest clients, and they were resounding in their simplicity and in their consistency. They said, "Mike, let me explain this to you. There's only a couple, truly independent technology services companies left on the planet. Most are associated with their own technology or there's something. There's very few really independent technology providers. And oh, by the way, we need CSC because you have intellectual property that we think can add value to our businesses going forward. We can't get access to that intellectual property or capital because we can't work through your organizational structure, your operating model. But we know it's there, and we'd like to be able to utilize that intellectual property going forward. And oh by the way, you, CSC, can scale with us globally." So that is the value proposition, a truly independent, objective technology services partner with very strong intellectual property, particularly around some of these key industries that can scale globally. The only problem was that it's something we couldn't actually do, but that is the value proposition. So again, very strong intellectual property, coupled with extraordinary skills of our people around the world, gives us an opportunity to not only scale those businesses, but then continue the investment around our leading-edge cloud offerings and our leading-edge Cyber offerings. So this, coupled with, as I said, our deep, deep customer relationships both on a federal level, as well as a state and local level or other centralized governments around the world and our commercial clients gave us a very, very strong value proposition to build around this core nugget of an independent technology services company with global scale.

So that led us very early to what do we want to be the best at? What do we want to put a stake in the ground and say this is what CSC stands for, and it's very simple? We want to be the leaders in the next generation of information technology infrastructure, and we want to be the leader in intellectual property and software assets in the consulting and application management, application testing around those key industry processes. So we want to be the leader in the industry solutions space in the industries that we are focused on. And by doing that, we think we can drive not only superior value for our clients, but superior value for our shareholders, and over time create an innovative, vibrant company that our employees can also grow and expand in as they go forward. And we have built 6 very simple strategies, which I will very briefly go through before Paul comes up. As you might expect, we had a lot of the basics that had to be fixed in this company. We have to expand our market coverage. This is a company that largely responds to RFPs. It doesn't go out and create demand. It doesn't have a well-established sales culture.

We need to move up the value chain. The profit pools in this industry have shifted over the last 10 years. We need to shift to where the money is, and we have been slow to do that. We need to scale out our leadership positions in cloud computing as a service computing, and leverage the fantastic Cyber skills that we've developed over the years. And then with all of the issues that surrounded CSC and open transparent accountable management system becomes an imperative as we go forward, so that we can have the debates, make fact-based decisions and then be held accountable, accountable by our shareholders, accountable by our clients and accountable by our employees for the value that we are able to deliver. So let me just very briefly go through each of these, and then the metrics that we are putting out there that we are going to be focused on over this turnaround time frame of 3 to 5 years. Over time, you'll see us report again some of these metrics. As we redo our financial systems, you'll see more of this as we go forward, but we're putting a stake in the ground, said "This is how we are going to measure ourselves." In short, this is what we need to be accountable for. So fixing the basics, the foundation is all about getting our cost structure right, reducing dramatically our capital intensity, much better discipline around our contract negotiation, contract delivery and services delivery, increase transparency by redoing our financial systems, HR systems and getting the right people into the company that can lead it and help us rationalize the structures that have been built up over the years.

So I've talked publicly about a cost reduction of roughly $1 billion over 18 months. We think over the turnaround time frame here of 3 to 5 years, there's probably closer to $2 billion that is available, things like reduction and procurement costs, reduction in organizational layers. I mean, for example, there's 12 layers of management between an account and me. I think that's a lot of supervision given the nature of our business. So we think there's opportunities there. Our finance people worked very hard and thank God, we've had them around given the financial systems we have in place, but we have over 3,000 finance people and we have 1,000 salespeople. And I think long-term, that balance is probably slightly out of whack, given the enormous market opportunity we have.

So we think there's also an opportunity to reduce our CapEx here around the IT infrastructure business to around 50%. So as we build our new capital allocation model, we want to commit less time to capital for our infrastructure business and more capital to acquisition opportunities or more capital that we can return to our shareholders.

We need to expand our market coverage. This is about sales, but it's also about developing a much more robust partner network that can help lead us into opportunities in the marketplace, expanding our presence with the Global 1000. And again, we've set some metrics here. We only have a relationship with 20% of the Global 1000 clients. And another area that offers a fantastic opportunities are cross-sell. So where we do have a relationship with the Global 1000, we only 3% to -- or 5% to 6% of the time have a relationship with another set of offerings that CSC has to offer in the marketplace. So we do very, very little cross-sell, which is a result of our organizational or operating model, and we'd like to get more revenue from our Global 1000. We get about 50% of our revenue today. We'd like to expand that. There's not a better place to go than to a client that you already have a good relationship with. I think today's announcement with Zurich Insurance is a classic example of that, where we had a very strong infrastructure relationship, and now we've been able to renew and expand the relationship we have with them around our management of their application portfolio, particularly their insurance applications.

The strategy of moving up the value chain is absolutely critical to us. And I said, "The other thing we want to be very good at is the industry solutions that support the industries that we're focused on," and we have set some very interesting metrics here for ourselves. The profit pools in this industry have shifted. In the red, there is the infrastructure business, where we get greater than 35% of our business today, yet the profit profile in that business is not particularly strong. This doesn't mean we're getting out of the infrastructure business. This doesn't mean this isn't important, but what it does mean is we need to move into those parts of the value chain that have much greater profitability associated with it. So next-gen infrastructure, cloud Cyber, much more profitable, where we have a very strong leadership position. Industry-specific software and applications, industry-specific business processes and then the business and industry consulting around that. These are significant profit pools, and this is where we need to remix our business and realign our resources to go after this opportunity, and where, by the way, we have the skills, the domain knowledge and the people to effect that move up the value chain.

As I said, strong leadership position in next-generation infrastructure, most notably cloud and Cyber, and we've set some very strident objectives here as well. We get roughly $100 million today from our cloud business. We'd like to increase that by an order of magnitude over this time frame.

Cyber, a very strong business today, but also a significant opportunity to scale that business and leverage what we've done with the federal government and leverage that to the commercial sector. And just recently, we signed a very large global media company, where we're now deeply involved with helping them with their Cybersecurity programs, and Big Data don't have much revenue associated with this today, but a fantastic opportunity around these industry solutions and industry processes. Healthcare industry comes to mind right off the top of my head, where all the information around outcomes of procedures and everything that's done in the healthcare delivery world, we can build capabilities for our clients around Big Data. And later this week, I will be announcing a new senior executive to lead that important market initiative for us as well.

As I said, we have over 2,000 customized offerings in the marketplace today at last count, and we uncover new ones every day. There's just no way you can run a global business with that set of offerings. That degree of customization leads to very high costs, lower margins, very difficult to innovate, very difficult to scale. So as we go forward, we want to reduce that 2,000-plus set of offerings to more in the neighborhood of a couple hundred. So this will be where we have standard architectures, standard reference platforms. So take an example of desktop outsourcing, something we call virtual desktop. We don't need 30 different versions of that. We need 1 version of that. So today, roughly 70% of our solutions are customized, 30% is standard. We'd like to reverse that over this turnaround time, where perhaps 70% is reference architectures, standard platforms and 30% is customized. So that becomes a major part of our strategy going forward.

And then finally, a very open, transparent, disciplined, accountable management system. We think this will drive better performance. It will drive better decisions. And we've designed a management system that has a great fondness for truth, for facts, for early warning of problems and for actions to solve rather than just report the problems that we have. Reporting problems is interesting. Solving those problems before they get to be big issues is what we would like to major on as we go forward.

Just to sort of wrap this up before I bring Paul up, we've laid this out over this time frame, and I think of this as a 3-stage turnaround. These stages are not sequential, they overlap, but I refer to them as get fit, win more and leadership. It's very simple. We've got to get the business fit, fix the basics. We then begin to have to grow, and begin to create some operating leverage by driving revenue as well as cost takeout, and then the leadership phase is where we can raise our hand and declare leadership in the areas that we want to be the best in, most notably, next-generation infrastructure, as well as our industry-specific solutions and the businesses that surround that. We've put a little roadmap together here, pro forma, we ended last year at $0.67 a share, and over this time frame, we'd like to get to a $5-plus per share. The early stage of this is primarily about cost takeout, about streamlining the business, streamlining the organization, and then we begin to get into more around market expansion, which will be very important to begin to create some operating leverage. So you can't save your way to prosperity. You get the cost structure right, but then you need to begin to drive revenue. We think as we expand this market coverage, this would be coexistent with us moving up the value chain and delivering a lot of the new offerings, particularly, again, around the industry-specific solutions and scaling out our next-generation infrastructure business and the continued process around rationalization of these offerings and moving to a much more standard architecture and set of offerings as we go forward. So these 6 strategies we've now feathered in over that 3- to 5-year period of time, and these are the metrics that we've set up for that 3-phased turnaround effort, and we've put in an operating model together that simplifies and drives the accountability and the transparency we've talked about.

There are some new numbers on this chart that you haven't seen before to give you a rough idea of the size of these businesses. We will not be reporting these businesses. This is a model, an operating model, we will begin to implement over the next year, but over time, we do expect to report the business more consistent with this operating model. So you can see our financial services business, the size of that healthcare manufacturing, diversified Public Sector and our federal business. These industries, along with federal government, are the organizations that are responsible for driving demand and improving the profitability and the relationships we have with the Global 1000. So that is their mission, very straightforward, very simple, and I think it is much clearer than what we've had in the past.

We've got -- a matter fact, let me just introduce Dave Zolet, if you could just stand. Dave has got the responsibility for our federal business, NPS. Let me just go down the other side of this. Jim, do you want to just stand up? Jim has got responsibility for the commercial industries in driving that Global 1000, and our regions in this model have the responsibility for our regional and local accounts globally. It's very large business. Our regions add up to almost $15 billion in revenue. So very significant.

And then on the left side, we'd taken all of our offerings in the company and consolidated them into 2 offering groups. The first offering group is our global business services, and this is responsible for our consulting, our industry-specific solutions and our application, meaning application management, application testing, application outsourcing, in some cases, business process outsourcing and in other instances, custom development. So this is where we want to move up the value chain. And I'd like to introduce Tom Hogan, and Tom Hogan, if you could just stand, he's got the responsibility for this business. It's roughly a $5 billion or $6 billion business today, and then our global infrastructure business is also a $4 billion to $5 billion business, and this is where we have our data center offerings, our communication offerings, our data -- I mean, our storage offerings, our network offerings and our workstation offerings, and Gary Budzinski, who's also new to CSC, has got the responsibility for that business.

So these 2 offering groups interact with the go-to-market groups, which are the global, commercial industries, Global 1000 and our regions that have responsibility for the regional and local accounts. And then because of their significance, cloud and Cyber and the data business, as you can see the rough size of those, I've pulled those out of the mainstream businesses and they report directly to me. So we are going to incubate these businesses, and what I mean by incubate is make sure that they get the necessary capital to grow. They get the necessary investment in terms of people and resources [ph] to pull that out and make those investments. And then in the right side are staff organizations that support the line, and underneath this is a set of global business processes like finance, like HR, like procurement, so that we can run the business consistently globally. So this operating model, in fact, moves us from a holding company mentality to an operating company, significant shift in the orientation of how we manage the assets of this company.

And then over time, over this turnaround period, this represents a significant remix of our business. So you can see our traditional infrastructure business there, where we want to see that go, how our next-generation infrastructure scales from roughly 4% to 20% to 25% of the business, you can do the math. But this moves almost 2/3 of the revenue-generation in CSC to the profit pools and up the value chain that we talked about earlier.

And over this period of time, we do expect revenue growth that will most likely come in the later stages. We do have some rationalization of our portfolio that is ongoing and needs to be done. So we see most of that revenue growth coming in the mid to latter parts of the turnaround. We've talked about the growth in earnings per share, so this is -- I think, it's a 40-some -- 45% earnings per share growth. But even if you subtract for the dismal year last year and normalize this to where the earnings projections are for this year, so 220 -- 2/3, it's about a 20% compound growth over this time frame, which we think is a pretty reasonable set of targets to set out there for this 5-year turnaround period, much greater free cash flow generation and as we've talked about before, much less capital to our business as part of our capital allocation model.

So just to summarize. This is the walk-through of how you get from $0.67 to $5 plus. This -- most of this we've talked about. What we're saying here is by 2014, we would like to be in the $3 plus per share range. Most of that, we get through the cost takeout program that we've already communicated, and Paul will go into a little more detail. We talked about the 300- to 400-basis point improvement in our margins. Some of that will be plowed back into the business. We have under many of our contracts we've committed cost and price takedowns. We've accounted for that. We will need to make some incremental investment in our systems, so we can run the business globally. And as we said, beginning to standardize our offerings and invest in market expansion, but the vast majority of this cost takeout will be returned to the bottom line. And then as we get past 2014, we begin to get some revenue growth, and that, coupled with mentality of productivity and other cost actions we are planning to take, that drives another 200 to 300 basis points of improvement, and that's how we get to the $5-plus per share.

Our commercial operating margins, this is new news. We haven't disclosed this before. You can see are less than 3% that grows dramatically over this time frame. We think 10% to 12% is probably a steady-state margin for the commercial business. Our federal business is currently about 6.4%, and we think the steady-state for this business is in the 8% to 9% range. In the government business, there is a limit to how much profits you can make. So when you mix this, this gets you a company that is driving margins in the high-single-digit, low-double-digit range and drives the kind of EPS growth that we have talked about.

So that's about as clear a walk-through as I can give you. Paul will give you a little more detail on how that plays out, so you see the substance behind that, but that is the financial walk-through for the business. We do have some risks. This is a fairly significant transformation of the business. This is not cosmetic. This is -- we aren't going to do the same thing, just do a little more of it. This is a fundamental rethink of the business and how -- what our value proposition is in the marketplace. There is risk associated with that. Now from my point of view, the risk associated with where we were had already clearly borne itself out. When you lose 60% of your market cap, that's what I call a risk having come true. So my way of thinking the risk, going forward, is less. As we go through the turnaround program, that risk mitigates as you forward. There is no question we are seeing delays in the federal government.

So the whole sequestration process, the so-called fiscal cliff that you hear about every night on the news is true, is delaying signings of deals. It doesn't affect revenue short-term, but it will if that persists well into next year, and I don't know. I have no idea, and I'm not sure the government has a great idea. That will play out over the next 90 to 120 days. We do have headwinds in our largest industry next to the federal government, which is the financial services. I don't need to tell anyone in this room what some of those headwinds are, but there -- certainly have some risks associated there.

In Europe, we are already seeing signs in Europe where a lot of the smaller deals are more difficult to close, sale cycles elongated, and Europe is an ongoing saga and it's different every week, and that gets played out in the papers in the financial markets, and I have no more insight in how that's going to go than you do, but it is a risk. And I frankly think that depending on how the election goes, we could have some changes in the U.S. healthcare, particularly, the subsidies. As you know, there's over $10 billion available for things like electronic medical records in the U.S. and depending on how that plays out, that could have an impact on our healthcare business, most notably our iSOFT assets as we go forward.

We have factored these risks into the aforementioned models. So it's not like one of these things, well let me tell you the model and let me tell you the risk, therefore, I don't mean it. We factored all these into these plans, and it's sort of in a midpoint case. So right now, we're assuming in Dave's business, the federal government, we're going to see a revenue decline of 5% or 6%. So we've set the cost basis up, the expense structure to drive the margins that I just took you through for that business given that decline in revenue. Now if it's much worse than that, depending on what happens with this fiscal cliff, come January 1, that could change, don't know, but that's what we factored into our plans so far.

So given all that, as I said, we have not been waiting for this presentation to get started. We are well on our way to implementation and execution. I will not go through all these things. But against those 6 strategies, we have taken some very strong corrective actions. We've completely realigned the executive compensation. The company realigned all of our equity plans to get them lined up. I'm a big believer that you must decide what you want to be good at. Then you need to put a strategy in place to get good at it. Then you need to make sure you have your resources actually lined up to do the work. And then you need to ensure that your measurement systems and your incentive systems are lined up. I will tell you that most of that was misaligned, and I can assure you that that is now aligned, and that work has been done. It's behind us. We've had a fantastic help from our board to get that all lined up, and we are beginning to march down that path now.

So with that, I'd like to turn it over to Paul, and then he and I will come back on stage and answer any questions. Is that right?

Paul N. Saleh

That is right. Thank you so much, Mike. Well, good morning, everyone. I'm pretty excited to be with you and share a little bit more of the specifics behind some of the charts that you saw from Mike. I'll be talking about the steps that we are going to be taking to deliver consistent financial performance. In particular, I'll go through our cost takeout program. I'll share with you our new financial model, what we're doing to improve our cash flow and what are our cash flow priorities.

As Mike mentioned, we have a $2 billion cost takeout that will take place over the next 3 to 5 years, and those consist of 2 types of cost. The first ones are listed on the slide, supply chain and procurement savings, workforce optimization, taking costs out of our overhead structure and also having greater contract management discipline, and then building on that over the next phase will be additional work on the enterprise system optimization will enable us to do greater use of shared services, and obviously, the standardized offering will also add to a more efficient cost structure.

So what I'm going to do now is take you into more detail across each one of those initiatives. Let's start with our supply chain and procurement area. We spent on last year about $7 billion in procurement. If you were to exclude customer-specified or pass-through type of purchases and other nondiscretionary spending, you're left with about a $4 billion to $5 billion of what we term addressable spend. Ten categories or so represent about 80% of that cost. What are we doing there is we're following actually a very detailed plan along 3 major lines. First is on category sourcing, making sure that we are renegotiating contract and down-selecting to fewer partners and fewer vendors. Second is that we're looking at demand management, making sure that we're only buying what we are obligated contractually to do and making sure that the timing of those purchases are essentially what we are can contracted to do, and most importantly also that we are complying with our own preferred sets of vendors.

Obviously, a procure-to-pay process that is streamlined will be also very helpful, as with the governance structure and managing our supplier base and making sure that they are complying with the standards that they have set out to deliver to us. Overall, from that area of addressable spend, we expect targeted saving of $350 million to $400 million over the next couple of years.

Our workforce optimization, Mike mentioned the fact that we are reducing the reporting layers from 13 down to 7. We also are broadening the span of control, asking our managerial positions to have a span of at least 7 direct people. We're also having an implementation of the consistent policies across contractors, new hire and moving very rapidly at dealing with underperforming staff. And finally, the increased utilization of offshore resources is going to be a key element of saving for us. You saw in the prior charts, we do have a lot of folks in low-cost jurisdictions. The key there is to better utilize those resources on account, and then this whole program is supposed to lead to a $250 million to $300 million of cost savings.

Moving onto overhead reduction. There are 3 areas of focus for us: G&A, IT, internal IT and facilities. Now I want to make a point here. This is not just the G&A that you see on our income statement corporate of about couple of hundred million dollars. This is the G&A, for example, that covers not only corporate G&A, but sector or the offering G&A, the regional G&A and the country G&A. When you look at this entire pool of overhead, it is really a significant amount of money, and we're going right at it.

Let me share a few things that we're doing. We are actually streamlining our corporate and business unit functions. We are really looking at consolidating those activities, and we're trying to eliminate redundancies. And more importantly, what we're doing is 0 basing those activities and benchmarking our performance against best-in-class companies. On the IT side, we are re-prioritizing our services, trying to redirect services to low-cost areas and rationalizing our entire IT project pipeline. And in the facilities side, we have -- on our K, you will find that we have 17 million square feet of space. Some of it is used for our data center. Some of it is for warehouses, but when you look at our office space, what we're trying to do is consolidate excess space. We are redefining our space standards. Some of you, when you'll come to visit us in our corporate offices, you'll see that firsthand. We're renegotiating real estate leases and exiting some owned and leased property, where we do not need. I think for this year, we will at least eliminate close to 1 million square feet of space as a result of that activity, and our objective there is to save about $200 million to $250 million to the bottom line over the next couple of years.

Now let me talk about contract management because it's an area that we have been very focused on, and it will lead benefit to us from a cost perspective. We're focusing on 3 areas: strengthening our process, our contract management process; improving the performance of what you've heard us term our focus account; and then balancing our portfolio of risk and return. More specifically on strengthening our contract management process, we have gone out and have looked and trying to -- we are implementing a consistent process across the entire company from capture to contracting to delivery to renewal. Across the company, it's the same process. We have strengthened and tightened our bid review and approval process with our delivery assurance, which does risk mitigation, risk management, really having a significant seat at the decision table. We also are developing economic game plans for every single contract that we are about to sign and what that means is that we're identifying the assumptions that are being made. We are also identifying the risks, asking for mitigation plans, an action plan to mitigate the risk, but also to price that risk in our bid portfolios.

And then we are also looked across the board at what were some of the areas that caused us some issues in the past, and as Mike indicated earlier, we're trying -- we are making sure that we're not repeating the mistakes of the past, but we've listed here some of the areas that caused us trouble in the contracts in the past. We're ensuring today that we have the right team composition on each one of our contracts. What that means is that we have the right account executive, but also the right solution architect with the right experience to bring to the particular contract we're looking at. We're also making sure that the scope is very well-defined and nailed down before a bid is finalized. We're also looking at the right governance for escalating and resolving issues that may arise in a contract dispute potentially. And we have continuity of coverage, not only during the bid process, but through delivery and involving the bid folks early on, much earlier on in the process and making sure that, that team is on the contract for the life of that contract, and finally, making sure that we have very clear transition plans that have very detailed timeline and detailed actions associated with that. Those areas of risk are being covered on every single pre-deal review to deal review, and we're making sure that we are green along all those 5 elements among others.

And also what we're doing is tracking the performance of these contracts early on, making sure that we have early warning signals, whether timelines are being missed, or what costs are just not aligning with what we had seen during the bid process.

Now let me move onto the performance of our focus accounts. We talked about some -- about 40 of them, but we have gone very deep across the entire portfolio of accounts, focusing on those that have in particular been performing below their bid model. We have reviewed them. We've asked the people, the management team that are managing these accounts to develop an action plan to close the gap to their bid model. Those accounts -- focus accounts are not all negative, many of them are. But the majority would be missing their bid model, and we're trying to close that gap.

Now let me give you a few things that we are doing that are enabling us basically to generate greater results. In fact, our first quarter performance demonstrate our progress along those lines. We have looked very tightly at focusing on our contractual commitment. You'll be surprised to know that in some of those accounts, we were really delivering services that were not part of our contractual arrangement and not being paid for them. So we went back to the customers and asking to be either paid for those services or we would just really move for services that were not part of our contractual arrangement with them.

We also instituted a very strict change control discipline around those contracts. So if the customer wants something new that's not in the contract, we'll ask that it be very clearly specified and we get paid for it. And in some cases, we have gone back and renegotiated terms with our customers.

Now you ask, what kind of things can you do? And I will just give you one example. In some cases we go in to our customers and ask them, for example, to rank prioritize for us what is most important for us -- for them from an SLA perspective. And what we have agreed with them, for example, it was be to tighten some of the SLAs and loosen some others that are not as critical to them, yet those are the SLAs that were costing us a whole lot of money to be able to deliver.

And finally, we are looking very clearly at our contracts to see if we cannot accelerate off-shoring of activities to be able to just drive our cost down.

Now, in addition to all of these things, we're looking at our entire portfolio of accounts and contracts to make sure that we're balancing risks and return. Obviously, you would expect us to do that and to want to avoid. What we're trying to do is avoid low return, high-risk contracts that we've had in the past, making sure that we are actually sustaining or growing those contracts and those opportunities that give us a high return and low risk. And in some cases, make the right strategic bet for some areas that may have some high return and high risk. Overall, what we're trying to do again is to have a portfolio of contract that have a balance of risks and return.

Objective in this whole arena is to have at least a $200 million to $250 million improvement over the next couple of years in contract -- coming from contract management discipline. We pointed to $100 million to $200 million this year, there's still more to be had in that area. So when you look at all of those 4 buckets together, they represent $1 billion to $1.2 billion of cost opportunities available to us, which were shown on Mike's prior slide.

But that is the first phase. The next phase will not only build on the progress that we will make through these 4 other areas, but we believe we have a great opportunity in moving to use greater use of shared services. On this slide, you will see in yellow the opportunities that we have to move greater of our activities, more of our activities into 3 of our shared services center. One in Sterling, Virginia; another 1 in Prague, in the Czech Republic; and then the last one in Chennai, India. We need to do that and the process, we believe, will have a greater percentage of our activities in shared services, low-cost center, and we will be able to drive our cost, our transaction cost by at least 25%. Underpinning that is this enterprise system optimization that we are implementing as we speak. The objective is to make sure that we have standardized processes across the company, that we are automating our controls. They are embedded in the system and in the processes that we are deploying across the company, that we're using common tools across the company, and also that we have data consistency across the company as well.

And finally, another area that is will deliver great results for us from a cost and efficiencies perspective is our standardized offering. The objective, as you heard, is to focus on differentiated and less capital-intensive offering, standardizing it and exiting also nonstrategic, low-margin businesses.

So that's what we're doing on the cost side. Let me just -- again, if we do that effectively -- this is the same chart that Mike just shared with you. By 2014, the first $1 billion to $1.2 billion, offset by some of the reinvestment that we're making in the business or savings that we have committed to give on -- to give to customers or some of the incremental restructuring. Net-net, we would expect that 300 to 400 basis points of improvement in our margins, in our EBIT margins. You'll see that over that timeframe. The next phase is additional savings, as I mentioned, increased use of shared services, the Enterprise System that would be enabling us to operate more effectively in the standardized offering, building on the success and the momentum that we would have in the first phase and we'll get to the 5-plus percent -- $5-plus per share. And then you can see the margins again improving that by 500 to 700 basis points across the company over the next 5 years.

So that's what we're doing on the cost side. That's the result of it and the new business model. Let me move on to talk about the driver of cash flow, because that's important. We want to make sure that we're driving greater cash flow from operations. First thing, obviously, all these things that I just shared with you will translate into a 500- to 700-basis point of improvement in margins, so a good thing to start with.

On the tax side, our objective is to be less than 35% taxpayer. And to do that, we're going to optimize our offshore mix of business. And the other thing that we're going to do is the use up our valuation allowance. We have a lot of NOLs, unfortunately, but that was the case. But we're going to take maximum use of those NOLs. In fact, the NHS contract settlement is giving us $108 million that will come our way tax-free just because again on the usage of our NOLs. And that we'll continue to look at R&D credit optimization and other type of efficiencies to drive that tax rate down.

Working capital is another area of opportunity for us. Our objective is to drive our DSOs down by at least 5 days. You saw some improvement in the first quarter of this year. We are determined to drive working capital down, and you see some of the benchmark here for us. And CapEx is the other big area of improvement for us. We pointed to a 50% or less of our capital allocation going to CapEx. And the way we're going to get there is by shifting the ownership, capital ownership model.

We're already working with our vendors and asking them to just really bear the capital requirement for some of the equipment that we are using. Storage as a service, for example, hardware as a service. In the past, we used our balance sheet. Basically people we're renting our balance sheet and we were getting paid over time or turning to our partners and asking them to do that. It's not the easiest thing to get going, but I'm telling you that we are making great progress in that area.

The other area of opportunity to drop CapEx down is our disciplined management -- capital management within the company, making sure that we are returning high return cost of capital so that discipline. And lastly, I would say to you the offering mix will also help us on the CapEx side. The objective there is to take our free cash flow to the point where our free cash flow conversion rate, so free cash flow of more than 100% of our net income. You heard us in the past it was in the 90%, 80% to 90%. It's going to be over 100% and I think hopefully starting sooner than later.

The other thing that we're doing is strengthening our balance sheet. We had a very good liquidity position at the end of the first quarter. We had $1 billion of cash on the balance sheet. $684 million of that was overseas. But I wanted to let you to know, we can access that cash very tax-efficiently. And the reason for that is, unlike other global companies, we're in a unique position of having loans from the U.S. parent through the subsidiaries, not the other way around. So as a result of that, it doesn't take a whole lot to be able to repatriate those funds to the U.S. if we wanted to use them.

We also pointed out a free cash flow from operation this year of about $300 million to $350 million, that's before the NHS settlement that just going to add $100 million to that. We are also looking at potential divestiture of nonstrategic asset that could also add additional liquidity to the company. And obviously, we do have access to the capital market, whether it's our commercial paper market or having bank loans and the like. And I should add also that we have $1.5 billion of credit facility from our credit line bank, and it has been undrawn but available to us.

What we're doing is trying to also address our debt maturity profile. We have 2 towers, 1 for 2013, $1 billion and another 1 in 2018 of another $1 billion. Our objective to strengthen the balance sheet is to smooth out our maturity profile, maintain ample access to liquidity and also have a strong, and I mean strong investment-grade credit profile. And the reason for that is it's very important for our commercial customers that are depending on us increasingly for their critical IT solutions.

I'll move onto our capital allocation, because that's another area of importance for us. If you look at the last 5 years, we spent over 60% of our cash on capital spending, CapEx. 25% or so went to acquisitions, and distribution to our shareholder was in the 10% to 15%. When you look at us versus our peers, on this slide, and I agree and we can discuss that some of those peers don't have the right mix, the same mix as us in terms of business mix. However, it is very instructive directionally, and that's one thing that's very important here. They have been less capital-intensive and they have returned more cash to shareholders.

I believe as we implement all of the things that we have shared with you today, our long-term objective would be to reduce our capital intensity and I've shared with you some of the things that we're doing there, maintain ample access to liquidity, generate higher return on our invested capital and most importantly returning more cash to shareholders.

That's the picture from the capital allocation. And so in closing, I'll show you our cash flow priorities. We're going to continue to reinvest in our business. We're going to make bolt -- we're going to pursue bolt-on strategic acquisition. We're going to ensure that we have a very strong financial position with ample access to liquidity. And then we also intend to return more cash to our shareholder from free cash flow. And with that, I'm going to turn it over to Mike for any closing comments.

J. Michael Lawrie

Very good. Thank you. So what we'd like to do now is just open it up to any questions that you guys have. I may get a stool here. We have some mics, I think, being passed around.

Question-and-Answer Session

George A. Price - BB&T Capital Markets, Research Division

George Price from BB&T. I wanted to just -- looking at Page 19 on the margin side, wanted to see if maybe you can give us a little more color at how you arrived at those ranges for your commercial and Public Sector government business? I mean if I look at Public Sector for example, just taking a quick skim back historically, I don't think that business has ever achieved that kind of profitability. If you look at the current peer group, they are generally for services at least in the more like the 7% to 8% range and headed down given increasing pricing pressure. So why would you be able for example to buck that trend? And on the commercial side, certainly for some types of businesses, those could be very reasonable margins. But maybe what's your -- can you give us a sense maybe of your ultimate mix behind what's going to drive those kinds...

J. Michael Lawrie

Well, that ultimate mix is on the page I shared with you. So if you go add up the remix of the business moving up the value chain and the margin spreads in those different businesses, and then you assume we're able to achieve that mix, that's what drives those commercial operating margins. So it's really just a math statement. Now it doesn't happen unless you do remix your business over that period of time. So to achieve those margins, you have to affect that shift. The next-generation infrastructure business has enormous upside profitability. There's 2 factors to drive profitability in cloud computing, it's utilization of the underlying fiscal assets, meaning data centers and compute capacity. And then where you have the labor Center to manage that compute capability. Those are all within our domain, our control, if you will. On the federal side, we do think we can get better margins and maybe Dave wants to talk about this. But one of the greater things we have going for us is we do not have a lot of programs that are tied to procurement of defense systems. We provide IT. And many of the peer groups that you are referring to are mix of IT infrastructure and services and solutions and other defense-oriented programs. So when you strip some of that out, we think we have an opportunity to get to that 8%, 9%, 10% range. Anything you want to add to that, Dave?

Unknown Executive

The only other comment I would make is, as you move more towards a -- the applications activities outsourcing the asset service model gives us an opportunity to realize higher-margins.

Paul N. Saleh

All right, I would like to just also to add, historically, we've gotten to the 8%. And first quarter in our Public Sector, we are at 7% plus margin. In the commercial segment, a lot of the cost takeout initiatives that we just really mentioned are going to be really a way to just really drive margins up in addition to what Mike has said about.

J. Michael Lawrie

One of the key things here, because I came into the company wondering, gee, should you really split the Federal business from the Commercial business? What's the synergies? Why have both? We just saw that a couple of weeks ago I think it was SAIC, split themselves up so they didn't make -- could remove some conflict of interest, which we don't have by the way for the reasons I just stated. But what we're seeing for the first time is that the federal government is actually looking now for commercial best practices. It's a first, I've been in this industry 35 years and been selling the federal government almost as long. Never have I seen this trend where the federal government now saying, "Hey, come to me with your best practice. What are you guys doing with cloud in the commercial world? Gee, I'd like to think about moving some of my IT capability there or moving to shared services centers." We have one of the world's leading-edge shared services centers for the federal government in Louisiana. Correct?

Unknown Executive


J. Michael Lawrie

Close. So we actually see synergies between the commercial business now feeding the federal business and I think I mentioned in my comments the deep work we've done with the national security agencies on Cyber and some of the capabilities that have been developed there and now being able to leverage those capabilities into the commercial world. So that cross-pollinization is actually giving us more confidence that we can drive these kind of margins, both in the federal as well as commercial.

Rod Bourgeois - Sanford C. Bernstein & Co., LLC., Research Division

Rod Bourgeois here from Bernstein. Couple of questions. Clearly, over the next 1 to 2 years, your turnaround plan is heavily contingent on taking out over $1 billion in cost. A lot of your cost are tied up in performing client-service functions as well as asset refresh requirements under your contractual obligations. Can you take out that level of cost without creating significant trade-offs in your relationships with clients and in your long-term ability to grow revenues from those clients? We've seen precedent in the industry that an aggressive cost takeout plan can significantly hurt a competitive position and revenue prospects. So how do you...

J. Michael Lawrie

That's an excellent question, I read that in your note about a month or so ago, so I'm prepared for it.

Rod Bourgeois - Sanford C. Bernstein & Co., LLC., Research Division

I might write it again too.

J. Michael Lawrie

You can write it as many times as you want, but I'll ask you to pose it with the answer in. We are not going to do anything that impairs our relationship with the client. You are absolutely right. You could go in and just slash and burn things in front of the customer. And you're right, you'll get some cost savings, but you're going to pay a big price for that down the road. We are not going to do that. And the reason is, we have ample opportunities elsewhere. I hate to admit this, but we've got over $1.5 billion in overhead. That, trust me, is not something our customers are begging us to keep in place. It is not adding value. 12 layers of management is not adding value to our clients. The fact that we do not centralize procurement. You see, we go to our customers and, "Listen, how would you feel if we were able to get this for 20% less and we pass along some of those savings to you?" They are not flinching at that. And then there are some positions that can be utilized more effectively offshore. See, the dirty little secret here is we had 23,000 people in India, fantastically skilled people. But we have basically the same functions that they're doing we have on the ground in our local geographies. So what we've built unwittingly is a mirror organization in India. So what we can do, and this is what Gary is working on one of these focus accounts, is identifying those positions that are not customer-facing. They support the account but they're not customer facing. And it doesn't make a darn bit of difference whether we perform that work in Chennai or Bangalore, or we perform at someplace else but has significant cost savings capability. So when you add that all up, we feel reasonably comfortable that we can achieve the kind of cost takeout numbers we're talking about without impacting customer value add. And by the way, we actually think we will improve the responsiveness.

Rod Bourgeois - Sanford C. Bernstein & Co., LLC., Research Division

Clearly, the G&A can be taken out without hurting the customer. But it seems like your biggest lever that you've spoken about is the procurement. So if you could elaborate a little bit on who you're renegotiating procurement deals with, it would seem that a lot of your assets that you're procuring are coming from IBM, HP, Dell and even Oracle.

J. Michael Lawrie

Okay. So let's take this -- it's another great question. So right now, every account, so 2,500 accounts, 600 or 700 of them are infrastructure accounts. Each 1 of those accounts negotiate separately with HP and Cisco and IBM and everybody else. So I called up, I won't name which, one and said, "Listen, I just took a look at this and we buy equipment from you and it ranges anywhere from a 30% discount to a 70% discount. I think the reasonable number is 62%. So now, what we'd like you to do is rebid that to us because we are going to consolidate that." When you have -- go back to this fragmentation point. When you have this fragmentation in the system, you don't really realize what you're doing to yourself. It has no impact on the customer. You're not even asking your partner. I got to give IBM credit. I mean, IBM actually came to meet and said, "You guys -- you're nuts, why don't you just aggregate some of this stuff? We'd like to help you out." Because we think by doing that, we can actually expand the market. So you've got $250 million, $300 million in procurement in there given what we spend on procurement, we're talking about 7%. So again, it's not a huge amount of savings, but a reasonable amount against the aggregate spend. So it's that fragmentation, I can't stress that enough that causes those inefficiencies.

Rod Bourgeois - Sanford C. Bernstein & Co., LLC., Research Division

Okay, and one final quickie. We've talked about this on the last couple of conference calls related to the problem contracts. Do you feel you had sufficient time to scrub your largest contracts to be comfortable that you really know what the true operating margin is on those deals today that they're being properly accounting for?

J. Michael Lawrie

I sleep like a baby. I wake every -- wake up every 2 hours screaming. No, we're not 100% sure. We've gone through them all. We have gone through them all. And we have made some significant progress in a relatively short period of time. I go through them monthly, Gary goes through them almost, what, every week? So what we're finding is we're getting a management system in place. As I've said, you and I talked about this, we're always going to have problem contracts. I just like to know about it before I have to write off $1.5 billion, that's all, so that we could maybe take some corrective action. And most of the time, the client is willing to do that. But we've had a culture of not wanting to confront the customer with scope changes, because maybe they weren't as happy with the delivery, so therefore we wanted to postpone the decision about the scope changes. And then 2 months passes and the next thing you know 6 months passes and you never ask it. We have a fantastic project management system that details every activity that we do. And what we found was hundreds of millions of dollars that were never billed, because we didn't want to ask the client. Am I saying this right, correct me if I'm wrong. So am I comfortable? No. Am I getting comfortable that we have a management system that is transparent, fact-based? People were afraid to come in and say, hey, I got a problem. Because we often would shoot the messenger. Now, the only way you get in trouble is if you don't put the facts and the truth on the table. So that takes a lot, but that's a cultural change. And it takes a while, people, to respond. Our transition management was not very good. I mean, in the transition, you can win or make all your money on a contract. We had a lot of issues with how we managed those transition. We've redone that process. So I think this is an ongoing saga. But yes, I'm more comfortable that we're building a management system to deal with it. We've had probably, what, 8 or 9 of the original focused 32 will literally fall off, meaning they're now making their bid models. These are not clients that lose money by the way, they're just aren't on their bid model. And we got much more accountability into the bid process. I mean people come in and say, "Well, that's going to make 12%." Well, who's willing to stand up behind those numbers? Nobody. Last time, you asked that question, nobody's standing up behind it. Well, that's what we thought we would you wanted to hear. That's what we had going on. Not no, here's the real thing, here's the risks, here's what we need to do in terms of getting the right transition management team, the right project management team, all these things in place upfront. And that's what our contract assurance process that we've put in place is now all about. So is it perfect? No. Will we have problems? Yes. I guarantee we'll have problems. Do we have a better handle on it? Yes, we have a better handle on it.

Paul N. Saleh

We have much more early warning signals on all of these things. And immediately, even during transition plans, as Mike raised that, if they are missing their timetable or if they are missing as I mentioned earlier their goal or the financial, they're automatically into deal review.

J. Michael Lawrie

We had a propensity in the company to delegate. So we have 12 layers of management you can do a lot of delegation. The problem is when you delegate like that, you often are delegating to levels or people that don't have the requisite business acumen or skills to make some of the right trade-offs. So that's what I mean by disciplined accountable management system. I expect all of my direct reports to be into the details of their brief. NHS. NHS, I think I mentioned every Friday I had a meeting with Kate over NHS. What are the issues? What did we get resolved this week? Okay, let's make this decision. Next week, what's the next set? And that's how we just plowed through it. And you have to have that rigorous operational excellence week-to-week if you're going to run a technology services business. That's -- jacks are better to play in this game. And if you don't want to do that, you shouldn't be in the business.

Jason Kupferberg - Jefferies & Company, Inc., Research Division

Jason Kupferberg of Jefferies. If we look at the new financial model going forward, it seems like you could break it arguably into 2 pieces. You got the fiscal '12 to fiscal '14 to get to the $3 a share and then fiscal '14 to '17 to get to the $5. Obviously, visibility higher on the first piece than the second. Just talk us through maybe your thought process and how you decided to establish the $5 number for '17. Get us comfortable with the visibility that you have on that, because it seems like that, that will really be the make or break for the stock at the end of the day. I mean you had a good move in the stock, because people comfortably believe, I think, a $3 plus number now, getting people to believe a $5 plus number, just talk about your comfort level there and how to get the street comfortable if that's achievable?

J. Michael Lawrie

Well, as we've said, we have a reasonable degree of comfort on the cost takeout. That is mostly within our control. So if we don't do that, that's execution failure on our part. And you're right, 2013 and 2014 is fundamentally about cost takeout. As I said, revenue will be flat to down most likely. And if we this is without any projections or rebalancing the portfolio as we take a look at exiting some of the businesses that are well below that operating margin model that we talked about. And if there's no prayer of ever getting them there, that's a good candidate to get rid of. The second half of this is we do see another leg of this cost takeout. It's a key message I wanted to deliver today, shared services. For whatever reason, CSC didn't get that memo that went out about 10 years ago about shared services. It was incredible to pull an eye when we went through this. But it's also a great opportunity. But shared services takes longer to get to, because you have to hire people, retrain people, there's a cost associated with that, and you can't get that done in a year or so. I've done it many times, and it just takes several years to do it. But it is there, and it does yield results. There's also no question that as we move to really globalized processes, we're able to take a lot of inefficiency out. I mean, we do not have a global HR system, Sineta [ph], who is our new head of HR, I'm not even sure who works for the company. Maybe that's good. But I don't know. And I'd like to know. I'd like to know how many contractors do we have in federal business. How many contractors do I have in India? Then am I getting rid for -- rid of some for performance and they're coming back the other door -- through another door? Don't know. I just -- I am admitting this, I don't know. But so as bad as that is, that is a fantastic opportunity. So we feel relatively comfortable with the cost takeout in the second phase of this. And then what we are assuming here is a very reasonable, we think, reasonable revenue increase of 3% to 5% in that second leg. And that gives us the operational leverage, because we're running some revenue through now a much leaner structure and a lot of that drops to the bottom line. So it's really just math. We have to get -- at the end of the day, you've got to believe 2 things about CSC. You've got to believe that these guys really do have a fair amount of cost they can take out. And yes, it think they probably can figure out how to do that. That's one thing, check. The second thing is you have to buy, is that the company has the intellectual property and has the people skills to begin to drive some incremental revenue in areas other than highly commoditized IT infrastructure. Those are the 2 bets that an investor and analyst that write about it have to be willing to make. And we think there are reasonable projections of 3% to 5% revenue growth in the second half, but you're right. Do we have complete 20/20 visibility to that today? No.

Jason Kupferberg - Jefferies & Company, Inc., Research Division

Just a follow-up on that. How would you break down the 3% to 5% longer-term revenue growth? And then can you just hone in on a couple of the operational risks. I think when you had your slide with all the risks at the top, it was operational risk, which is obviously kind of a catchall statement if you could may be hone in a couple that continue to...

J. Michael Lawrie

So the areas that I think we will -- I have great confidence in our iSOFT business. I mean, having just gone through the negotiation with NHS, believe me, I know what we have and what we don't have. Because part of the NHS agreement is I wouldn't do a deal unless we agreed on what the solution was and what the price was. No more, "We'll build this in 5 years." No, no. It's got to be here, it's got to ship, it has to be installed and it has to actually be working. And then here's the price and we agree on the price. We've done that. So I know that capability is here. I know the demand for these healthcare software assets is huge around the world. Huge. We have been 100% focused on NHS. So we have not leveraged that asset. We're not even in the United States. Last time I checked, we spent a fair amount of money in healthcare in the United States. Seems to me like not a bad place to be. But likewise in Asia. Likewise in other parts of Western Europe. So we have great confidence in that. We have great deal of confidence in this next generation infrastructure. A lot of confidence in it. Paul and I, when we got here, we did not have an economic model under that business. "It's great, it's going to be great." I've seen a lot of "it's going to be great" before. So we dug into it, what is it? We know what the levers are, what money can be made there. So we have a great deal of confidence that we can move in that direction. And one other detail, why? Why? Because we can dis-intermediate ourselves, i.e., cannibalize our own business. Why? Because we make 3% on it. If this stuff was making 15%, you would be a little less eager to go in and upset the apple cart. But when you're making 3%, and you've got another opportunity here that can generate 16% to 20%, and in some cases allow you to make your SLA agreements more effectively, you're not afraid to do that. And that's just within our own install base. We have not assumed in this model anything outside our install base. That's the other confidence factor we have. I don't know if that answers your question. Risk, big risk is people because front row. 70% new. When you bring 70% people in they’re new, and they bring in 50% that are new, and that starts rippling through the organization, you changed processes, you have some risk. That risk mitigates over time. But again, in our case, because of the performance, I'd argue that there's more downside risk staying the way you were than where you are. Now the one thing about the front row, the team we brought in here, these are not guys that require training wheels. So this isn't their first time on a 2-wheeler. So they got their big boy pants on and they're ready to go out for stage 7 of the Tour de France now. Let's go pedal. So they know how to do it. Gary's done this, he's run infrastructure for HP and EDS. He knows how to do this. Tom's been the CEO of an application software company, has software for HP, knows how to do these things. So what we've tried to do is bring a team in here that have a proven track record of what needs to be done. And then finally is the goodwill of the employees and CSC. CSC employees are embarrassed, they're disappointed, they're upset what has happened to their company. By and large, they love CSC. They have great pride in CSC for all the reasons I showed you, all the things that they've accomplished. This team ran IT for the Apollo space mission. This is the same team that ran IT for the Hubble Telescope, and the Hubble Telescope rescue mission. These are a proud group of people, and they were angry at what happened to their company. And they want to see it get better. They know there'll be some risk. They know there'll be some changes. But they're mature enough to recognize that sometimes you do have to pay a price to get back on the trajectory you want to get on. It's probably more than you wanted, right?

Unknown Analyst

What percentage of your revenue now is kind of problematic or 0 margin business? Because I'm just trying to...

J. Michael Lawrie

We'll go to that pie chart. You see this thing called other in there?

Unknown Analyst

Which page is that? Sorry.

J. Michael Lawrie

The one I showed you up here. I don't have the page numbers. But it's like -- I think it was 30%, was other, right? So in that are some businesses that have significantly lower than our target operating margin profile. So not all of that is below our target margins, but quite a bit of it is below our target margin. So that would be an example of revenue that I'd say probably if I had to take a guess, this would just be a guess, probably somewhere in the neighborhood of $500 million to $750 million that are well below the target range, and we don't think are fixable.

Unknown Analyst

So should we sort of base it kind of $15 billion when we? Just because I...

J. Michael Lawrie

I'd say somewhere between $15 billion, $15.5 billion, something like that.

Unknown Analyst

And then just second question I had was on corporate G&A, because you guys gave a EBIT margin number, then you give operating margin by segment. Can you give us a little color on what that number is?

Paul N. Saleh

The EBIT corporate was about 1.4% or so of revenues. And the objective is, long term, is to be below 1%.

Unknown Analyst

And just the last question is, who do you guys kind of want to be like? Do you want to be like an Accenture or IBM? Or do you guys kind of say, hey, there's a lot of opportunity away from kind of those bigger guys? Can you give us...

J. Michael Lawrie

That's a great question. That was definitely part of the strategic work. We do not want to be like IBM. IBM is a great company. They have built a fantastic global services franchise. I'm sure they're going to do well. I'm not interested in going, attacking IBM. I'm not particularly interested in trying to attack EDS. That's not what we're trying to do, or Accenture for that matter. Accenture is I think probably one of the best-of-breed in the industry, no question about that. We think there is ample opportunity in spaces that are little smaller and would not move the needle for some of those other larger competitors. Let me give you an example. So take banking. So we said we want to be the leader in banking processes, both the consulting, the application software, the application testing, application integration, maintenance, et cetera associated with that. I'm not interested in going, doing a financial process for a company. Accenture can do that and can do that very well. What I'm more interested in is syndicated lending within capital markets. It's a sub-process. It is a sub-process. So it's measured in hundreds of millions of dollars, not tens of billions of dollars. But there's a huge need to automate and integrate those processes. It requires deep domain knowledge. You do not get someone from Asia somewhere and assign them to syndicated lending process and they're experts within 2 weeks. This requires years of knowledge and years of practicing in that area. That's what we have in this company, is those skills. Now we just designed a Workmen's Compensation claims process for a large international insurance company. Within 3 months, we were able to get up and running and deliver it as a cloud-based service. Those are the processes we want to get into, and that will have the net effect of not bringing us into direct, overt, head-to-head competition with some of the bigger players. So it's really more of the latter. We think there's great market segments and niches underneath those larger players that we can exploit, that we have the skills and the intellectual property to exploit.

Keith F. Bachman - BMO Capital Markets U.S.

Keith Bachman from Bank of Montréal. I have 2 sets of questions, 1 is on revenues and then second on cash flow. But you talked a little bit about the growth. The whole revenues flat here for the next 2 years, and that's if there's no dispositions. But can you talk about the context of the government within that? You said you included some of the assumptions for government in that context. But what are the assumptions?

J. Michael Lawrie

The assumptions are federal government revenues will decline 5% to 6% over that time frame.

Keith F. Bachman - BMO Capital Markets U.S.

So when you said sequestration was included within that, that's the likely range of outcomes you think gets to that 5% to 6%?

J. Michael Lawrie

That's the midpoint of our assumptions. And there -- that we don't know exactly how this will play out. I mean, we have a pretty big business with the Defense Department, which is one of the areas that could be impacted. But many of the services, IT Services, will have to be continued. It's not like discontinuing or pushing off a new fighter program for 3 years or delaying this or delaying that defense program. These are services that will have to be delivered. They may not grow, but we think they'll have to be delivered over this timeframe. That is our midpoint assumption.

Keith F. Bachman - BMO Capital Markets U.S.

Fair enough then. On the free cash flow, you indicate that you're looking to move to 100% -- or greater than 100%, excuse me, of net income. There was no timeframe reference to that. And then as a part of that, on Page 35, where you talk about the peer comparisons for acquisitions and capital allocation to shareholders, there's a pretty wide -- a huge range there. Is there any more specifics that you can give us and how you're thinking about those objectives?

Paul N. Saleh

Right. I think we said free cash flow over 100%. Obviously, the working capital will help. The capital spending will also help. I think even this year, we'll be approaching that level. If you look at the guidance that we gave up 210 to 230 in EPS when you look at the 300 to 350, this is even before the NHS. As you'll see that, we're getting there much faster. I think, obviously, as we deliver on the cost-reductions, you'll see that translate a whole lot faster sooner rather than later. This is not a mere 5 kind of a thing. And so I would say that that would be the thing on the free cash flow.

Keith F. Bachman - BMO Capital Markets U.S.

The second part was the range that you're thinking...

Paul N. Saleh

Well, the range is very difficult, because you have people like Accenture, for example, that may be returning in an average of maybe 60% to 80% of their free cash flow to their shareholders. And you have others in the group that are much more on the lower end. What we're trying to show you here is just visually a very clear understanding of what we're pointing to. Less capital-intensive, continue to generate more cash from operation. And if that's the case, we will have a whole lot more flexibility and an intent of returning more cash to the shareholders in the form of -- distribution to them in the form of whether it's dividend or share buyback or a combination of the 2, but from free cash flow.

J. Michael Lawrie

The only thing I'd point here is, at the end-of-day, it's can you earn your cost of capital? If you can earn your cost of capital, you got to give the money back to the shareholders. I mean this is not -- this does not require a PhD in EE. And unwittingly, over these last several years, we've had a borrowing cost of 8% to 10%, and we've reinvested that in an IT infrastructure business that has returned 3%. That's not a sustainable strategy. That's what we've done. So at the end of the day, these are our ranges. But the base assumption is, whether it be a bolt-on acquisition to improve our analytics capability in the Healthcare business or a bolt-on acquisition to improve our Cyber security capabilities in the commercial sector or our cloud capabilities, those have to earn at least its cost to capital. Otherwise, you should give the money back. Now I sold some businesses, Allscripts, a couple of years ago. We honestly did not have projects that could return in excess of our cost to capital. So we gave all the money back to the shareholders, because that was the most accretive thing to do. So that's the baseline, is can you return your cost of capital? And assuming you can, then what Paul provided was sort of a mix of how you continue to innovate, drive your business going forward. This is not about how you slash and burn this company so it doesn't exist as it goes forward. It's about strengthening and building off the heritage of innovation and extraordinary capability with clients. I think we only got -- how much time we have here? Time for one more? It's pretty convenient.

Unknown Analyst

You talked about -- I'll actually make it 2 parts just so I could squeeze one in here, like any good analyst. But you talked about how you go from customization to standardization. How do you not affect execution? Because isn't customization, by definition, the domain expertise that you're bringing?

J. Michael Lawrie

No. No. I mean, the reason we have so many and, I'll have Gary chime in if he wants to, the reason we have so many offerings was due to fragmentation. So we had an account in Japan that wants to build a virtual desktop offering. They never -- there was no mechanism in the company to go back and say, "Have you guys done that in Europe? What did you learn in Europe?" So there was no mechanism to do that. So we had no, what I call, standard reference platforms or standard architectures. So that's how we wound up with 70% customization on almost all of our offerings. What we want to do is we want to build a virtual desktop standard architecture. I mean, if you are outsourcing the management of desktops, desktops are desktops. Now is it a little different desktop for Barclays than it is for some other company in another industry? Yes, there may be different applications. So you have to customize the offering to the industry, in some cases customize it to the individual client. But there's no reason to have 70% customization. And the only reason that happened was the fragmentation. I know we said holding companies are a great thing until they no longer work. Then it's a real problem. Because you just can't share in a holding company mentality. And I, personally, this is Mike Lawrie's opinion now, don't think holding companies work in the technology services industry. Period. There is no existence there for a good operating with disciplined and operating excellence holding company in the technology service industry. Why? Because our clients tend to buy everything we have to offer. So they aren't easily categorized into pieces. If you got jet engines and submarines, that may be different. You can manage those businesses differently and get operational excellence in each of those businesses. That's very difficult to do when all the stuff comes together in front of the same customer. So that's what's led to the high degree of customization. And I think, it hurts implementation. I don't think it improves it. I think it hurts it. Because you're constantly relearning everything that you have learned everywhere else, and we have made this mistake, our desktop offerings -- again, correct me if I'm wrong. Just shake your head yes if I'm saying this right. I mean we probably knew the first 3 that we did. Here are the 5 things that you shouldn't do. But I got new for you, the 200th one were still making those first 5 mistakes. That is not a good way of operating.

Unknown Analyst

And the last one for me just, you talked about Europe financial services and healthcare. In the guidance of the projections, are you expecting a stable environment? A slight decrease? Are you putting any kind of -- if you can just give us some idea of how you...

J. Michael Lawrie

Basically, what we're assuming for Europe is pretty much what we've seen the last year. So I have my own personal opinions on what's was going to happen in Europe, which I won't share here, but we've assumed pretty much status quo. We don't see it blowing up, so we don't see the euro falling apart. Most of Europe is already in recession, we see that continuing at least for the next year to 2 years. So pretty much what you see today is what we have assumed in these financial models.

Okay. Well, listen. And we'll have more time to share. Paul and I are going to make ourselves available. We've already been out to meet with many of you. We'll do that again. I do appreciate your time. And again, I just like to leave you with we think this is a very strong global franchise. And we look forward to delivering a little more value over this turnaround period of time. Thank you very much.

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