Good day, ladies and gentlemen, and welcome to the Leidos First Quarter Fiscal 2015 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I will now turn the call over to your host, John Sweeney, Senior Vice President of Investor Relations. Please go ahead.

Thank you. Good morning, everyone. I'd like to welcome you to our first quarter fiscal 2015 earnings conference call. Joining me today are John Jumper, our Chairman and CEO; and Mark Sopp, our CFO; and other members of the Leidos management team. During the call, we'll make forward-looking statements to assist you in understanding the company and our expectations about its future financial and operating performance. These statements are subject to a number of risks that could cause actual events to differ materially, and I refer you to our SEC filings for a discussion of these risks. In addition, statements represent our views as of today. Subsequent events and developments could cause our view to change. We may elect to update the forward-looking statements at some point in the future, but we specifically disclaim any obligation to do so. I'd now like to turn the call over to John Jumper, our Chairman and CEO.

Thank you, John. Our first quarter results for fiscal year '15 and our second full quarterly reports since the separation reflect the continuing challenges we face in our various markets while also demonstrating some positive results from our actions to improve operational performance. We continue to make meaningful progress on mitigating the impact of government spending levels and shedding impediments to our future growth. We are cautiously optimistic about recent contract activity in some segments of the federal market, federal health in particular. However, our outlook and our experience in defense and intelligence budgets show outlays continuing to decrease through the government's fiscal year '15. We also believe that dramatic differences and priorities between political parties may result in another continuing resolution in the upcoming new government fiscal year, which starts October 1 of this year. Leidos continues to take actions necessary to become more competitive in both federal and commercial markets. I remain convinced that we're doing a good job, improving upon these areas within our control and that we are extracting the value we envisioned in the separation. We saw our National Security Sector operating income improved, as well as an increase in the sector's funded backlog. And we continued on our journey to shape and optimize our portfolio, completing the sale of CounterBomber, our third divestiture in recent months. We also had success in our efforts to access markets that were either partially or fully conflicted before the separation, seeing strong new awards amounting to more than $400 million in airborne systems, command and control, and logistics. In addition, we have taken initial steps to build our international presence with both government and commercial business where we see demand for our demonstrated solutions. These steps are being taken in a small number of countries, where we have…

Great. Thank you, John. Consolidated revenues were $1.3 billion for the first quarter, which represented a decline of 17% year-over-year and consistent with our expectations. Operating income margin was 6.7%. This is below our full year expectation of a low- to mid-7% range due to a higher-than-anticipated loss on our Plainfield energy plant operations and the timing of severance- and regulatory-related charges in our corporate sector. At the same time, I'd like to highlight progress on improving our margin profile. Our National Security Sector posted a margin of 8.2% in Q1, benefiting from strong program execution, and we generally expect this level of performance throughout the year. Our Health and Engineering Sector operating income margin was 6.6% in Q1, depressed by the Plainfield results and by low sales volume of our higher-margin security products, as John said. We expect improvement in these 2 areas for the rest of the year. These factors together drove operating income of $89 million for Q1 and a year-over-year improvement of 17% despite a reduction in revenues. Interest expense was $20 million in the quarter, tracking to our expected normalized level for the year. Our share buybacks reduced our diluted shares outstanding to 78 million, down from 84 million in the fourth quarter of last year. This should adjust down to 75 million to 76 million in Q2 as we get a full quarter's benefit from the $200 million buyback we launched in March. Diluted EPS from continuing operations was $0.59 for the first quarter, and our non-GAAP EPS was $0.60 per share, which excludes $1 million of separation and restructuring expenses stemming from an adjustment to a reserve for facilities' lease terminations. Operating cash flow was negative $8 million in Q1. The first quarter, as John said, is typically the low point for cash…

Thank you, Mark. As we report our second full quarter of performance under the Leidos banner, I have watched a resilient management team and a talented team of employees take on multiple challenges, sequestration, government shutdown, a new company name and significant structural change. I am confident we are positioned better than ever to take on the uncertainties of our environment and to deliver to our shareholders the value that was envisioned when we created Leidos. Now let me turn the mic back over to John for your questions.

Thank you. Operator, we'd now like to open up the line for questions.

[Operator Instructions] Our first question comes from Cai Von Rumohr with Cowen.

Could you give us a little color on the tone of bookings at NSS? Some of your peers have indicated they've started to see a pickup. And maybe quantify for us -- you were down $78 million in OCO volume, how big was it in that first quarter?

Cai, this is John Jumper. We've got Lou Von Thaer here with us today as part of the management team. So I'm going to let him field that question.

Cai, so we -- $78 million was our first quarter impact on order -- on revenues being down from the actual OCO. A lot of this comes with timing, and if you look at our submittals for the quarter, they were a little bit lower in the first quarter. But in the next couple of quarters, we have a couple billion-dollar-plus bids that we expect to go out that have been delayed. These things will all settle out in time, and we actually expect to see our submittal numbers increase quite a bit. If you look back over the last couple of years, with the government budget challenges, we've seen most of the awards come through in what would be our third quarter, and we anticipate that will happen again this year.

And then to my first question, the other question about the level of OCO revenues in the first quarter?

Cai, this is Mark. We're still on pace to have roughly $400 million for the year. It will modestly decline as we move through the year with some scheduled ramp-downs, but that overall $400 million expectation for the year is unchanged from our previous discussions.

Yes. I think it's pretty linear, Cai, but that's with some noise on it.

Got it. And then the last one, maybe you could update us in the commercial health IT area, how that did, what the order looks like, and whether we're starting to see any pickup there.

Cai, this is John Jumper. I think we're encouraged about commercial health, but we've had some ups and downs. As you know, the Meaningful Use in the ICD-10 decisions have been pushed out to the right again. So this has not had the impact that we saw previously with those decisions, but still, it's room for caution. So it's still too early to -- I think, to call a turnaround in that business, although we have seen some improvement.

Our next question comes from Jason Kupferberg with Jefferies.

I just wanted to start with a -- kind of a high-level question. I'm trying to sort through the implications of what's happening kind of on the OCO side with a troop drawdown versus what's happening with kind of broader sequestration. Can you just kind of parse those for us and help us understand if you think that things have kind of bottomed out or not purely from kind of a sequestration standpoint? Or is there still another leg to go there?

Let me start out with sort of a budget outlook from a strategic level. I think that -- I think it's encouraging that we have a budget agreement, but I think if you look closely at the lag of outlays, actual government outlays, I think that we are in for continued pressure and declines at least through the government fiscal '15. And so I think that pressure continues, and we're probably less optimistic than others about that situation. With regard to the impact of the OCO, I think we are going to see the continuing troop drawdowns, but it is unclear how the impact this is going to have on businesses like ours in that environment. We -- you know that we are looking forward to continuing reductions, but I think the final impact is difficult to predict. I'm going to let Lou comment a little bit more on that.

Yes, I think John got that just right. The only other piece I would add is within the overall government DoD budgets, if you look at the procurement and RDT&E sections of those budgets, they're under even more pressure because personnel costs, facilities costs, a lot of the non- or less-controllable costs continue to increase for the Department amidst the declines. And as a result, while we look forward to being more optimistic, we see more pressure on these budgets for a couple more years.

Okay. And then going back to your comment earlier, I think you said you derived about $11.9 billion in bids outstanding as of the end of the quarter. What percent of those would you estimate could be decisioned by the end of the government fiscal year, as well as by the end of the Leidos fiscal year?

Well, let me start. I'm going to say that one of the characteristics of the situation we're in is that decisions, in general, are being pushed to the right. So I've mentioned this on previous calls that the delays in decisions are the things that are probably one of the most harmful aspects of sequestration, and quite frankly, we don't see much improvement in that.

Okay. So no specific percentage that we should be thinking of as parse?

I think it would be disingenuous of us to try and parse any answer to you on that.

Okay, okay. And then just last one, which sort of ties into this prior question, but as you think about the prospect for government flush in September, compared to what we saw or, for that matter, did not see last year, I mean, are you expecting it to be similarly tepid? Or could it be less tepid than it was last year?

Well, again, I think we're under a new set of rules as we try to figure out the real impact of sequestration, the delayed decisions, the delay in RFP, et cetera, all of the push to the right. It's difficult to say. I can only say that there's no reason to believe it won't look like last year. We don't see anything, quite frankly, that much different in the current environment. So while I think it's impossible to predict, I'd say that the logic would tell us it would look very similar to last year here in the sort of sequestration [ph] ecosystem that we're in -- we find ourselves in right now.

Our next question comes from Robert Spingarn with Crédit Suisse.

This is actually Joe on for Rob. Mark, you noted that Q1 is typically the low point for cash flow generation, and I just wanted to ask how should we think about the cadence for cash flow in the remaining 3 quarters and how you kind of get to the $350 million level that you're guiding to.

Okay. Thanks, Joe. I mentioned in my prepared remarks, we had an extra payroll and incentives in Q1. So those incentives won't happen again for the rest of the year. So you'll see improvement in the out quarters from that alone relative to Q1. We do have an extra payroll again in Q3, and so there will be a little bit of pressure there. So all other things being equal, I'd expect Q2 and Q4 to be better. We do expect to see DSO reduction over the course of the year. I expect that to be somewhat gradual, but specific initiatives and catalysts for that are well in mind and are of very, very high priority. So it will build over the course of the year, and there will be quite a bit in Q4. So it will come down to the wire, but I can assure you this team is laser-focused on it, and we're confident in our outlook.

Our next question comes from Joe Nadol with JPMorgan.

It's actually Chris Sands on for Joe. I just wanted to follow up on the commercial health-care outlook. I know you said it remains uncertain, but can you say that it was profitable in Q1 and what your expectation for the full year is?

Mark?

Commercial health was profitable in Q1. It actually had a healthy margin. So we were really pleased to see that in both the absolute and relative to recent quarters. General outlook is relatively flat on the top line given the pipeline we see and the uncertainty that John referred to earlier. We expect to be profitable for the year. Margins will move around a little bit with timing of investments and bids and things like that. And so we're expecting to be, for the year, well above last year, which was not a great year. I would not say our margins are going to be optimized this year for that business. We still are making investments, and we don't quite have the volume we'd like to see to really get to what you might expect for a commercial consulting business. So we've got a ways to go there, but at least we're in the black relative to recent quarters and we're pleased to see that progress. And hats off to the team for their progress there.

And so is that low- to mid-single digits? Is that reasonable for what you're expecting this year?

It's more in the mid, maybe a little plus.

Okay. And then when you said flat for the rest of the year, did you mean relative to Q1 on the top line?

I missed that question. I'm sorry, Chris.

When you said flat for the remainder of the year, did you mean relative to Q1 on the top line?

Basically, give or take a little bit, it's sequentially flat, going out, is our current view.

Okay. And then switching over to the federal health outlook. John, in your prepared remarks, I believe you said that you'd seen some positive indicators there. Can you give us an update on the outlook there and potentially in the near-term opportunities you're going after?

Yes. One of the favorable elements of the federal budget is there's been a considerable uptick in contracting activity in the federal health side. As you know, we have coming up this competition for the defense health medical records, the DHMSM contract, which is the digitization -- re-digitization, actually, of the Department of Defense electronic health-care records system. It's a system that we've been actually running for -- we've won the competition, and we've been running it for some 25 years. So I think this is going to be an excellent opportunity that combines the best of commercial and federal -- or commercial efficiencies to the end of the federal space. So we think we're well positioned there, and again, I think the outlook here is very positive.

What's the timing on the DHMSM contract?

Well, they just released the final section of the RFP. So as I will refer back to my conversation previously about delayed decisions, I'm not going to predict when we might actually have a bid on this, but I think it's going to be in the months to come.

Our next question comes from Bill Loomis with Stifel.

Mark, you mentioned, on NSS, the margins will be sustained, but when I back out the project adjustment, I get 100 basis points lower if I just take that off the operating income. So when you say that, do you expect additional project write-ups or that write-up to get offset by cost reductions kind of keeping that low-8s-type operating margin through the year in NSS?

We are looking at low-8s going forward, and I think that our performance on projects is reflected in some of those write-ups. I think the team has done a marvelous job at stabilizing and improving our performance on our programs across the board. And so the write-ups do reflect that, but they also reflect the ongoing cost reductions that Lou and his team have engineered into the business. And cost reductions work their way favorably into contract adjustments, and there's an element of recurring nature in that. In addition to that, we do have some higher-margin specific projects that are either under our belt or within our visibility that also should fuel some improvement in the out quarters. So it's a combination of strong program performance on past and ongoing cost reductions and also some mix improvements going forward that are real drivers for our expected modest improvement moving forward.

Okay, great. And then on the -- that you said -- mentioned Plainfield cash grant, can you get into that a little more? And how much of that -- is that part of your operating cash flow guidance, what the amount is, and what that comes from?

So the Plainfield Treasury cash grant is not part of our operating cash flow guidance because it will be a receipt into the investing activities category, and we expect it will offset our CapEx. And that is why I said we expect net inflows from investing activities for the year fueling more capital deployment opportunity. We filed our Treasury grant application early in the fiscal year, and it's going through its normal process. We are having dialogue with the Treasury Department now, which I would categorize as normal. And with that, we expect to receive proceeds in the second half of the year, as I said earlier. And we've said before that that's nominally a $70 million number, which is part of the overall carrying value of the plant, which is at $275 million.

Any update on your potential sale of that?

Well, we, as you know, we've -- as we said, we filed for the cash grant. We are working on the performance parameters of the plant, and so we plan to get the plant up into fully operational mode and do everything we can to maximize the value to our shareholders.

I'll just clarify. It's operational today.

Yes.

It's -- we're working on optimizing its performance. And once we have that well under our belt, it's when we can be better positioned to access the market to maximize shareholder value in a monetizing transaction.

[Operator Instructions] Our next question comes from Edward Caso with Wells Fargo Securities.

I was curious in your thoughts of a recent commentary from President Obama, maybe a change in strategy here and how that might impact areas that you're targeting going forward?

Which comments, Ed?

Primarily the ones at the naval -- West Point.

The -- talking about the global strategy?

Yes.

Well, I think you're putting me on the spot here because the commentary on that speech is -- in many cases, has been rather critical. But I think that where that speech left us is sort of back in the middle. I mean, the President talked about sort of extremes of possibilities but left us in the middle with regard to -- and the things that actually have been said before with regard to using allies and others to help us out in our global posturing. I don't think there's anything here that we see is going to affect, at the boots on the ground level, the activities that we see in the future. I think when you break that down to what we do in intelligence, what we do in cyber, what we do in other areas of national security, I just don't see how that -- anything he said makes a difference in what we do. I think, if anything, it puts additional pressure on being able to quickly respond and to be agile to a rapidly changing situation in the world. And, of course, as you know, Ed, that's our forte in this company. That's what we do. So we're ready for whatever does take place.

And any thoughts on the turmoil over at the VA? Do you think that has the chance? And obviously, VA is important to the federal health opportunity, whether that may cause some delays in any of these contract awards?

Well, we are -- first of all, let me say we're not involved in any of the major work that goes on over there. We do have some minor positions, and we're very proud of that, working with our veterans. But I think that what we're seeing in the VA is unique to the VA. I think it doesn't take away from the requirement to move out. As a matter of fact, it probably amplifies the requirement to move out with the Department of Defense electronic health-care digitization program, as envisioned. And it sort of amplifies that sense of urgency to be able to take advantage of our technology to be able to do these functions that are still surprisingly being done manually in many areas of what we assume to be a technically proficient market, but we're not there yet. So I think it amplifies that requirement, Ed.

It seems that Congress is more than willing to use the OCO budget to do things that maybe aren't quite OCO work. Does this give you an added level of comfort that change will be more gradual?

Yes, this is Lou Von Thaer. And yes, I think we will see some of that. I think some of the places where we believe we'll be able to transition some of our OCO work into programs of record, I think, in transition through this, already some of those assets are being used in other continents today at small levels. And we think this will -- this -- I -- we think it supports our strategy. And the recent announcements that the President made on when we would potentially end the conflicts in Afghanistan, I think, are pretty consistent with our expectations of the plan that we have laid out.

And, Ed, this isn't new. I mean, we've seen this before with the OCO budgets not always being entirely focused on OCO activity.

Last question, pricing, sort of maybe a combination of pricing ad recompetes in the forward 12 months of your -- how much exposure do you have on recompetes? Sort of what's the win rate been recently? And what kind of pricing both on takeaway and on recompete activity are you seeing?

So this is Lou. I'll take that one as well. So we're obviously seeing a very challenging pricing environment. At the same time, our recompetes are at about a normal level for us. We usually run about 20% of the business or so that we recompete for each year. Prices are tight right row, which is why we are being very aggressive in the cost-cutting activities that we're continuing to do, and quite frankly, our win rates have been great lately. Our win rate, actually, for the National Security Sector was up in the mid-60s, which is our highest in the last 5 quarters over the last quarters. These things are all kind of cyclical and ebb and flow. We believe we're still very competitive, and we believe we're continuing to rapidly adjust to these pressures.

Our next question comes from Bill Loomis with Stifel.

Just a couple more. First, on the book-to-bill on Health and Engineering 1.0, so you highlighted 2 of the wins that totaled about $27 million, but what was the bulk of the rest of those to get to that 1.0?

Bill, it's Mark. Okay, this -- there is no one big one that dominates the landscape there other than the ones you mentioned and maybe some other announcements that are -- that we've announced over the course of the quarter. But the health business is very fast churned, and so that isn't surprising to consistently run at 1.0. And we improved sequentially in revenues, and so that went in the right direction. It's really a lot of activity, fast churn all over the place, in both the federal engineering, commercial engineering and commercial health and federal health areas. So I can't point to anything that you would recognize that moves the needle there.

Okay. And then on cash use, you said excess cash is over $200 million. You have $1.3 billion in debt. What are your plans? It kind of sounds like you are leaning more towards special dividends or something of that nature, but what are your views on acquisition opportunities as well?

Bill, this is John. We -- the strategy remains the same. The priorities remain the same, and so I think the board, as I said earlier, considers these things at every meeting. We have a meeting coming up again. So there's no reason to believe that there's going to be a change in the strategy that you've seen in the past.

So you would be comfortable if you've paid out all your cash? And your $200 million in cash, you've got $1.3 billion in debt. You would be comfortable leveraging up, potentially, several hundred million to go for an acquisition or...

This is something the board considers every quarter. So I'm not going to be predictive in any way, Bill.

Okay. But you don't want to prioritize where the deployment would go at this time?

Well, we said that our regular dividend is the highest priority. We said that. We've laid out the other options that are considered duly on a quarterly basis.

I'm showing no further questions at this time. I will now turn the call back over to John Sweeney for closing remarks.

Thank you very much, everybody, for joining us today. We look forward to updating you on our progress as we move through the rest of the year. Have a good day.

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect, and, everyone, have a great day.