DXC Technology Co

NYSE:DXC

Earnings Call Transcript 2018-Q4

[Operator]

Good day, and welcome to the DXC Technology Fourth Quarter and Fiscal Year 2018 Results Call. Today's call is being recorded.

At this time I would like to turn the conference over to Mr. Jonathan Ford, Head of Investor Relations. Please go ahead sir.

[Jonathan Ford, Head of Investor Relations]

Thank you and good afternoon everyone. I'm pleased you are joining us for the DXC Technology's fourth quarter and year-end fiscal 2018 earnings call. Our speakers on today's call will be Mike Lawrie, our Chairman, President and Chief Executive Officer; and Paul Saleh, our Chief Financial Officer. The call is being webcast at dxc.com/investorrelations and we posted slides to our website which will accompany the discussion today.

Slide 2 explains that the discussion will include comparisons of our results for the fourth quarter and full year fiscal 2018 to our pro forma combined company results for the fourth quarter and full year fiscal 2017. The pro forma results are based on the historical quarterly statements of operations of each of CSC and the legacy Enterprise Services business of HPE or HPES, giving effect to the merger as if it had been consummated on April 2, 2016.

As a consequence of CSC and HPES having different fiscal year-end dates, the pro forma combined company results include the results of operations of CSC for the three and 12 months ending March 31, 2017 and of HPES for the three and 12 months ending January 31, 2017.

Slide 3 and 4 as our participant -- the DXC Technology's presentation includes certain non-GAAP financial measures and certain further adjustments to these measures, which we believe provide useful supplemental information to our investors. In accordance with SEC rules, we have provided a reconciliation of these measures to their respective and most directly comparable GAAP measures. These reconciliations can be found in the tables included in today's earnings release, as well as in our supplemental slides. Both documents are available on the Investor Relations section of our website.

On Slide 4 you'll see that certain comments we make on the call will be forward-looking. These statements are subject to known and unknown risks and uncertainties, which could cause actual results to differ materially from those expressed on the call. A discussion of risks and uncertainties is included in our quarterly reports on Form 10-Q, our annual report on Form 10-K that we'll file in the next few days and other SEC filings. I would like to remind our listeners that DXC Technology assumes no obligation to update the information presented on the call, except as required by law.

And now I'd like to introduce DXC Technology's Chairman, President and CEO, Mike Lawrie.

[Mike Lawrie, Chairman, President and Chief Executive Officer]

Okay, thank you. Welcome everyone. Thanks for taking the time this afternoon. As is my practice I've got four or five key points which I'll go over briefly and then get into a little more detail before I turn it over to Paul and then we'll have plenty of time for any questions that you may have. So, first point here is our fourth quarter non-GAAP EPS was $2.28. For fiscal 2018 our non-GAAP EPS was $7.94. Adjusted EBIT was $1.17 billion in the quarter and adjusted EBIT margin was 16.2%. For fiscal 2018 adjusted EBIT was $3.499 billion, and adjusted EBIT margin was 14.2%.

We generated $557 million of adjusted free cash flow in the fourth quarter and for fiscal 2018 adjusted free cash flow was $2.427 billion. Our revenue in the fourth quarter was $6.294 billion, on a GAAP basis and revenue grew 4.3% year-over-year and was up 1.7% sequentially. In constant currency revenue was down 1.3% year-over-year, is roughly flat sequentially, and for fiscal 2018, revenue was $24.556 billion, the book-to-bill in the fourth quarter was 0.9, and for the full year it was 1x.

In the fourth quarter our digital revenue grew 21.6% year-over-year and 8.5% sequentially. For fiscal 2018 digital revenue grew 17%. And in the fourth quarter our industry IP and BPS revenue was up 7.9% year-over-year and was up 5.7% sequentially. For fiscal 2018 our industry IP and BPS revenue was roughly flat. In the fourth quarter, our digital book-to-bill was 1x and our industry IP and BPS book-to-bill was 0.7.

Throughout fiscal 2018 we achieved key merger integration milestones and exceeded our synergy targets, delivering $1.1 billion of year one cost savings as well as $1.6 billion of run rate cost savings exiting the year. Also the separation of our U.S. public sector business in combination with Vencore Holding Corporation and KeyPoint Government Solutions will close at the end of this month forming Perspecta. And for fiscal 2019, we are targeting revenue of $21.5 billion to $22 billion which excludes the USPS business. And our non-GAAP EPS target is $7.75 to $8.15 and our adjusted free cash flow target is 90% or more of adjusted net income.

So let me just delve into little more detail in each of those. As I said our fourth quarter non-GAAP EPS was $2.28 and the effective tax rate was 29.4%. For fiscal 2018 non-GAAP EPS was $7.94 and the effective tax rate for the full year was 28.3%. Fourth quarter EBIT adjusted for restructuring integration and amortization of intangibles was $1.017 billion, and adjusted EBIT margin on that basis was 16.2%, which was up 600 basis points year-over-year and up 127 basis points sequentially.

For fiscal 2018 adjusted EBIT was $3.499 billion and the adjusted EBIT margin was 14.2% an improvement of 460 basis points. This margin improvement reflects execution of the synergy plans we outlined at our Investor Day last March including workforce optimization, supply chain efficiencies, policy harmonization and facilities rationalization.

Our delivery teams continue to drive increased productivity, while improving service levels for our clients. We've scaled your Bionix automation program to more than 50,000 employees in our delivery centers. These improvements address capabilities such as service tasks, incident management, server provisioning to eliminate labor, reduce disruptions and accelerate resolutions. For example, we deployed runbook automation to diagnose the most common application faults in developed scripted resolutions which then trigger predetermined corrective actions. In centers where this has been implemented roughly 70% of instances are auto diagnosed and resolved. During fiscal 2018, our Bionix program reduced our delivery labor expense by more than 3%.

In supply chain, we've scaled are labor improvement actions to extract greater efficiencies from third party spend including reduction of hardware and maintenance expense. Through our relationship with Turbonomics we were able to optimize workflows and cloud environments to increase utilization of virtual machines and reduce the infrastructure cost. We're also enhancing our delivery capabilities to handle more data center maintenance work internally, which reduces third-party expense, as well as dependence on equipment manufacturers.

We're further lowering maintenance expense through the deployment of consistent architectural standards, and client solutions, which improves predictability and reduces overall support costs. Collectively we delivered $1.1 billion of year one synergy realization versus our target of $1 billion. And adjusted free cash flow for the quarter as I said was $557 million or 84% of adjusted net income and for fiscal 2018 adjusted free cash flow was $2.427 billion or a 105% of adjusted net income.

Now let me turn to revenue. Revenue in the fourth quarter was $6.294 billion on a GAAP basis. Revenue grew 4.3% year-over-year and was up 1.7% sequentially. In constant currency revenue was down 1.3 year-over-year and was roughly flat sequentially. Book to bill in the fourth quarter was 0.9x. For fiscal 2018, revenue was $24.556 billion on a GAAP basis, and in constant currency revenue was $24.2 billion in line with the target of $24 billion to $24.5 billion. Book to bill for the year was 1x.

Now in the fourth quarter GBS revenue was $2.361 billion. GBS revenue grew 3.3% year-over-year and grew 2% sequentially. And this I think reflects the continued shift from traditional application services to enterprise and cloud applications. We're working with our clients to standardize and rationalize our application portfolios, which typically involves a shift from legacy custom applications to packaged enterprise applications such as Workday, SAP, Oracle and Microsoft Dynamics. Through the consolidation of application providers these workload transformations often result in greater revenue for DXC while lowering the overall cost for our clients.

GBS book to bill in the quarter was 0.9x and for fiscal 2018 GBS revenue was $9.254 billion, and a book to bill of 1.1x. In the quarter GBS segment margin was 19.9%, compared with 12.4% in the prior year. And for fiscal 2018 GBS margin was 16.9% which was up 480 basis points from the prior year. In the fourth quarter GIS revenue was $3.223 billion. GIS revenue grew 3.3% year-over-year and 2.5% sequentially. GIS revenue reflects growth in cloud and platform services as well as mobility and workplace.

Workplace and mobility grew 7.8% year-over-year and was up 67% year-over-year in bookings. This includes a new logo win with a major automotive manufacturer. Working with Microsoft, Citrix and ServiceNow DXC will deliver workplace and mobility services for the entire company across more than 125,000 users and 1,400 locations. Overall GIS bookings were $2.9 billion which were up 11% year-over-year and represented a book-to-bill 0.9x.

For fiscal 2018 GIS revenue was $12.479 billion and the book-to-bill was also 0.9x. In the quarter, GIS segment margin was 14.8% compared with 11.4% in the prior year, reflecting productivity improvements in the automation process. In fiscal 2018, GIS margin was 13.6% which was up 340 basis points from the prior year.

During the fourth quarter USPS revenue was $710 million, USPS revenue was up 11.1% year-over-year and was down 2.2% sequentially. USPS bookings of $522 million represent a book-to-bill of 0.7x. For fiscal 2018 USPS revenue was $2.83 billion and a book-to-bill of 0.7x. The USPS segment margin in the quarter was 17% and this was up 710 basis points year-over-year, and 180 basis points sequentially. And for fiscal 2018 USPS margin was 14.8%, which was up 390 basis points from the prior year.

I'll talk more in a moment about the separation of USPS business and the combination with Vencore and KeyPoint. And during this first quarter of operation DXC expanded its client base by adding more than 90 new logo deals greater than $1 million in total contract value.

Now let me turn to digital. Our digital revenue was up 21.6% year-over-year and was up 8.5% sequentially. Digital book-to-bill was 1x in the quarter and as we've discussed digital cuts across all three of DXCs reporting segments of GBS, GIS and USPS and includes enterprise cloud apps and consulting cloud infrastructure, analytics and security. And for fiscal 2018 digital revenue grew 17%.

Enterprise cloud apps and consulting revenue was up 38% year-over-year and up 88.5% sequentially. Book-to-bill in the quarter was 1.2x. This growth reflects continued traction with our clients including a recent app transformation deal with a major communications provider. By consolidating its portfolio under a single service provider we are reducing their operational costs, driving consistent and improved service levels and reducing overall risk through more stable business operations. We're also deploying application development as a service which gives the client access to a highly flexible resource pool while providing predictable pricing for project work.

Cloud revenue was up 29% year-over-year and was up 12.6% sequentially. Bookings were up 50% year-over-year with a book to bill of 0.9x. Drivers of the revenue and bookings growth in cloud include a major deal with a large healthcare company. DXC partnered with the client to create an everything as a service solution across hardware, software, facilities and services incorporating offerings from Microsoft Azure, Dell EMC, HPE, HP and AT&T. This transformation allows the client to reduce its operating budget while also avoiding significant capital expense. In selecting DXC the client highlighted our experience in clinical healthcare technology infrastructure, our unique healthcare cloud on Azure solution and strong existing application support.

Analytics revenue was down 3.8% year-over-year but was up 9% sequentially. We continue to gain traction across our client base as we drive adoption of Artificial Intelligence. For example we're working with automotive manufacturers to accelerate autonomous driving R&D, and we detect possible money laundering crimes for financial institutions. Book to bill in the quarter was 0.7x. Security revenue was down 1.3% year-over-year and was up 1.4% sequentially. We continue to invest in expanding our security consulting capabilities, as well as our standard mobile security delivery platform. Book to bill in the quarter was 1x.

Industry IP and BPS includes our IP offerings in healthcare, insurance, travel and transportation and banking, as well as our industry BPS business. Industry IP and BPS revenue grew 7.9% year-over-year and was up 5.7% sequentially. Book to bill was 0.7x in the quarter. For fiscal 2018 industry IP and BPS revenue was roughly flat. Industry IP revenue grew 7.3% year-over-year and was up 5.9% sequentially. Industry IP growth was primarily driven by strong revenue performance in our healthcare sector, including growth in our state Medicaid accounts. Book to bill in the quarter was 0.4, reflecting the lumpiness of contract awards in this segment.

BPS revenue was up 8.5% year-over-year and up 5.5% sequentially. Book to bill in the quarter was 1.1x. Revenue growth reflects the continued ramp up of our large BPS contracts with insurance companies. We also continue to modernize our portfolio with a focus on robotics for shared services, including the launch of Bionix as an offering. Bionix provides an industrialized operating model leveraging analytics and Artificial Intelligence, Lean process design and leading automation capabilities to create comprehensive high-performance approaches to services delivery. DXC launched Bionix in response to client demand for greater IT performance and the need to digitally transform traditional IT environments and processes.

In the quarter we continue to expand our offerings and partnered solutions including the launch of DXC Open Health Connect, a digital health platform that allows healthcare providers to improve quality of care and patient outcome by providing data when and where it is needed across the healthcare ecosystem. We co-created Open Health Connect with a large academic and research hospital system in New York and have also worked with several of our strategic partners including Microsoft and ServiceNow.

In response to our client's need for an accelerated process to evaluate and transform their applications state we created the DXC Modernization Studio. The studio features 48 client experience datasets with data from 500,000 enterprise applications. DXC leverages the studio provide clients with an assessment and recommendation in as little as two weeks, a process that used to take up to six months. And we're investing in our people and we're investing in our business consistent with the plan we outlined at Investor Day.

We recently announced the acquisition of Sable37 and Ebix which will be combined with DXC's Eclipse practice to significantly expand our Microsoft Dynamics 365 Cloud capabilities globally. This represents a key part of our strategy to leave the Microsoft partner marketplace and accelerate digital transformation journeys for our clients. We also continue to invest on our people. DXC employees completed more than 1.5 million hours of training with a heavy focus on digital certifications and AWS, Microsoft Azure and Dynamics, ServiceNow and Agile development.

We also expanded our sales training and certification program beyond our go-to-market teams and more than 17,000 employees have completed the training and passed the certification exam. And we continue to expand the DXC Dynamic Talent Cloud, our cloud sourcing platform that enables us to bring new people skills to DXC in a more flexible way. We are working with partners such as Upwork, PoliTricks, HackerEarth and LinkedIn to scale the platform and we now have more than 7,000 subscribers engaged.

Once again DXC was ranked in the top 20 on Corporate Responsibility Magazine's ranking of the 100 best corporate citizens. This ranking recognizes DXC's performance across seven categories; environmental impact, climate change, employee relations, human rights, governance, finance, philanthropy and community support.

One the fourth point that I wanted to just get into little more detail before I turn it over to Paul, we continue to achieve key merger integration milestones during the fourth quarter and really successfully completed the overall year one integration roadmap for DXC. We delivered $1.1 billion in year one cost savings versus the target of $1 billion and $1.6 billion of run rate cost savings exiting fiscal 2018 versus the target of $1.5 billion. The separation of U.S. public sector business in combination with Vencore and KeyPoint to form Perspecta will close of the end of the month.

Integration activities for Perspecta have gone well and the company is set to begin operating as a stand-alone company. The operating model is in place and the leadership has begun to execute as an integrated team. And importantly, the response to the launch of Perspecta has been consistently favorable from key stakeholders. Perspecta held its Investor Day earlier this month and will begin trading on the New York Stock Exchange on June 1st. The Perspecta management team will continue meeting with investors, employees and partners over the coming weeks to discuss the new company and we at DXC plan to hold a separate Investor Day this fall.

Now finally, during our first year DXC did track a bit ahead of plan on revenue. And when we set our revenue target at $24 billion to $24.5 billion, we expected 2 to 3 points of revenue dissynergy during the year. We continue to see this playing out. But, so far we have seen less impact than what we had expected. Profits during the first year were also better than expected as we were able to accelerate many of the cost takeout synergies, including reduced management layers and global deployment of our automation program Bionix. We also benefited from lease reclassification, tax reform and a one-time FX gain.

Turning to next year, for fiscal 2019 we expect revenue to be $21.5 million to $22 billion which excludes the USPS business. There are several positive things contributing to that target, as well as a couple of mitigating factors. We continue to accelerate the growth in our digital and industry IP offerings and our BPS business is also demonstrating strong momentum. We do expect some additional revenue dissynergies next year, as well as the ongoing headwinds in traditional services that we have previously discussed.

Also, the revenue from our HPE contract associated with the merger will normalize this year at a bit lower rate and we continue to gauge the potential impact of Brexit in our UK business. We're targeting non-GAAP EPS of $7.75 to $8.15 and adjusted free cash flow to be 90% or more of adjusted net income.

And with that, I'll turn it over to Paul and then we'll come back to answer any questions.

[Paul Saleh, Chief Financial Officer]

All right thank you Mike and greetings everyone. Before I review the fourth quarter and full year for DXC I'd like to take a moment to clarify the basis of our financial presentation. First, all the references to the unaudited pro forma statements of operations from the prior year include the results of operations of CSC for the three and 12 months ended March 31, 2017 and of HPES for the three and 12 months ended January 31, 2017. Second, the fiscal '17 pro forma statements of operations and those have been now revised to reflect purchase price accounting and lease adjustments as if the merger had occurred on April 2, 2016.

In addition we have continued to assume a flat tax rate of 27.5% in the prior year pro forma non-GAAP results. And lastly our non-GAAP results exclude special items such as restructuring, integration, separation and amortization of intangibles consistent with DXC's non-GAAP method from prior years.

And with that I'll now [Technical Difficulty] items that are excluded from our non-GAAP results this quarter. In the current we have restructuring costs of $208 million pretax or $0.50 per diluted share. These costs represent severance related to workforce optimization programs and expense associated with facilities and data center rationalization. Also in the quarter we had a $124 million pretax or $0.33 per diluted share of integration, separation and transaction related costs. Amortization of acquired intangibles was $153 million pretax or $0.37 per diluted share in the quarter.

Also in the quarter our annual re-measurement of pension assets and liabilities resulted in a gain of $203 million. So adjusted EBIT excluding the impact of these special items was $1.017 billion for the quarter and non-GAAP EPS was $2.28. For the full-year restructuring, integration, separation and transaction costs amounted to $1.2 billion pretax or $3.06 per diluted share which is below the $1.3 billion spend envelope we laid out for fiscal '18. Amortization of acquired intangibles was $591 million pretax or $1.37 per diluted share for the full year. Adjusted EBIT for the full year was $3.499 billion and non-GAAP EPS was $7.94.

Turning now to our fourth quarter and full-year results in more detail. Revenue in the quarter was $6.294 billion on a GAAP basis. Revenue was up 4.3% year-over-year and 1.7% sequentially. In constant currency revenue was down 1.3% year-over-year and roughly flat sequentially. For the full year revenue was $24.556 billion on a GAAP basis, in constant currency revenue was $24.2 billion in line with our fiscal 2018 target of $24 billion to $24.5 billion. EBIT in the quarter was $1.017 billion after adjusting for special items. Adjusted EBIT margin on that basis was 16.2% compared with 10.2% in the prior year and 15% in the last quarter.

For the fiscal year 2018, adjusted EBIT was $3.499 billion and adjusted EBIT margin was 14.2% up 460 basis points versus the prior year. The improvement in profitability reflects cost actions taken to optimize our workforce, harmonize our policies, extract greater supply chain efficiencies and rationalize our real estate footprint. In the fourth quarter we continue to rebalance our workforce. We've reduced our labor base by an additional 2.2% in the quarter through continued deployment of our automation program Bionix as well as additional best shoring and pyramid correction.

For the full year we've reduced our labor base by 12.6%, net of new hires and contractor conversions. We continue to rebalance our skill mix, including the hiring of roughly 20,000 new employees during the year with a significant focus on digital capabilities. In supply chain we continue to extract efficiencies from our third-party spend and we've reduced third-party labor expense by roughly 6% during the year.

We're also reducing our hardware and maintenance expense by optimizing workflows to improve utilization of virtual machines and leveraging internal capabilities where feasible for the highest volume maintenance activities. In real estate we eliminated an additional [Technical Difficulties] space during the quarter and for the full year we've reduced our total square footage by 4.7 million square feet, representing a reduction of almost 20%.

So in summary we delivered more than $1.1 billion of in year savings, which translates to roughly $1.6 billion of run rate savings exiting the year. Excluding USPS in year savings were approximately $1 billion in fiscal '18 and run rate savings exiting the year were $1.4 billion. In fiscal 2019 we're targeting an incremental $400 million of in year savings in addition to the run rate benefit from the actions taken during fiscal 2018. Now the combined savings of $800 million will be partially offset by $200 million to $250 million of headwinds including stranded G&A costs, the [Q1] FX benefits and the off to cap lease impacts.

We're also planning to reinvest an incremental $200 million to $250 million from those savings in the business in line with the capital allocation model we outlined at our Investor Day. Now these investments include the continued deployment of the DXC digital platform Bionix, enhancements in our digital workforce and capabilities, BPS Agile and Robotic process automation and Blockchain capabilities.

Non-GAAP diluted EPS from continuing operations in the fourth quarter was $2.28, adjusted for special items. And for the full-year non-GAAP EPS was $7.94. In the quarter our non-GAAP tax rate was 29.4%, reflecting our global mix of income and an unfavorable valuation allowance related to tax attributes in certain foreign jurisdictions. And for fiscal 2018 our non-GAAP tax rate was 28.3%, which was in line with the non-GAAP tax targets for the full year of 25% to 30%. Bookings in the quarter were $5.4 billion for an overall book-to-bill ratio of 0.9x. And for the full year bookings were $23.67 billion for a book-to-bill of 1x.

Now let's turn to our segment results. Global Business Services revenue was $2.36 billion in the fourth quarter. GBS revenue was up 3.3% year-over-year and was up 2% sequentially. In constant currency revenue was down 2.2% year-over-year but flat sequentially. In the fourth quarter GBS segment profit was $470 million and profit margin was 19.9% compared with 12.4% in the prior year and 18.6% in the third quarter. This margin improvement reflects cost take out actions. GBS bookings were $2.04 billion in the quarter for a book-to-bill of 0.9x. Now for the full-year GBS revenue was $9.254 billion, segment profit was $1.563 billion, margin was 16.9% and bookings were $10.2 billion for a book-to-bill of 1.1x.

Turing now to Global Infrastructure Services revenue was $3.223 billion in the quarter. GIS revenue was up 3.6% year-over-year and was up 2.5% sequentially. In constant currency revenue was down 3.2% on a year-over-year basis but flat sequentially. In the fourth quarter GIS segment profit was $477 million and profit margin was 14.8% compared with 11.4% in the prior year and 14.7% in the third quarter. Profitability improvements in GIS reflects the impact of cost actions we have taken to drive greater operating efficiencies including best shoring, labor pyramid rebalancing, benefits from our Bionix automation program and supply chain savings. Bookings for GIS were $2.86 billion in the quarter for a book-to-bill of 0.9x. For the full year GIS revenue was $12.48 billion, segment profit was $1.7 billion, margin was 13.6% and bookings were $11.6 billion for a book-to-bill of 0.9x.

Now turning to the USPS business, revenue was $710 million in the quarter up 11.1% year-over-year and down sequentially. USPS segment profit was $121 million in the quarter and profit margin was 17% compared with 9.9% in the prior year and 15.2% in the third quarter. The year-over-year margin improvement reflects cost actions taken during the year. Sequential margin improvement was driven by cost optimization ahead of the spin-off, as well as the timing of milestone and award fees.

Bookings for USPS were $522 million in the quarter for a book-to-bill of 0.7x. For fiscal 2018 USPS revenue was $2.82 billion, segment profit was $417 million, margin was up 14.8% and bookings were $1.9 billion, for a book to bill of 0.7x.

Now let me turn to some financial highlights for the quarter. Adjusted free cash flow in the quarter was $557 million, or 84% of adjusted net income and this reflects the annual 401(k) match payments and seasonal higher -- seasonally higher payroll taxes. Adjusted free cash flow does not include any proceeds from receivables securitization program. For fiscal 2018 adjusted free cash flow was $2.427 billion or 105% of adjusted net income. Our CapEx was $471 million in the quarter or 7.5% of revenue and for the full year CapEx was $1.76 billion, or 7.2% of revenue.

Now, during the quarter we returned a $123 million of capital to our shareholders, consisting of $51 million in dividends and $72 million in share repurchases. And for the full year we've returned $311 million of capital to our shareholders, of which a $174 million was in dividends and a $137 million was in share repurchase. And for fiscal 2019 we expect to resume our pace of share repurchase in line with our capital allocation model.

Now today our Board authorized an increase in our quarterly dividend to $0.19 per share, as well as $0.76 per share for the full year of fiscal 2019. DXC will not adjust its dividend as a result of the spin out of our USPS business. Therefore, shareholder will receive this dividend in addition to any dividend paid by Perspecta. Cash at the end of the quarter was $2.6 billion. Our total debt was $8.4 billion including capitalized leases. Net debt to total capitalization ratio was 25.8%. Now as part of the USPS spin off DXC is expected to receive $984 million from Perspecta. On that basis, the net debt to total capitalization of the company would be 18.8%.

Now let me close with fiscal '19 targets, all of which will now exclude USPS. Our targeting revenue for the fiscal year to be $21.5 million to $22 million. This compares with $21.7 billion in fiscal '18. Our fiscal 2019 target for non-GAAP EPS from continuing operations is $7.75 to $8.15. Now this compares with roughly $6.70 for fiscal 2018, which was recast to exclude earnings-per-share associated with the USPS business and adjusted for any stranded G&A cost. Our EPS target assumes a tax rate of 24% to 28% for the full year and our adjusted free cash flow target for fiscal 2019 is 90% or more of adjusted net income.

Now I hand the call back to the operator for a Q&A session.

[Operator]

Will take our first question from Ashwin Shirvaikar with Citi.

[Ashwin Shirvaikar, Citi]

I want to start with asking Paul can you talk about the cadence of revenues and profit improvement for the quarters through fiscal '19 as the layout and perhaps also provide clarification on some of the basic stuff and I can expect in FX will impact kind of the mixed pack state and the share comp that you are using?

[Paul Saleh, Chief Financial Officer]

Yes. So I think right now if you look at the guidance that -- the target that we have given you for the full-year of $21.5 billion to $22 billion, it will be right now -- and we expect that this is again for the commercial business only because USPS is going to be spun-off as of June 1st. I want to make sure everybody is clear on that. And I think what we will see is a relatively consistent performance throughout the year growing a little bit more in the second half of the year on a sequential basis. I mentioned the tax rate again of 24% to 28% I think using a midpoint right now would be appropriate and as I mentioned we will resume our share buybacks so we would expect to retire more shares this year than we have done this past year and will try to catch up on our capital. There is something aligned more with our capital allocation model.

[Ashwin Shirvaikar, Citi]

Got it. And the incremental synergies $400 million it sounds good on top of what you have already achieved. But can you speak as to whether that includes the impact of Bionix and I guess the improvements seen on a smaller scale as you try these things out but the industrialization of Bionix can you talk about that the potential for that?

[Mike Lawrie, Chairman, President and Chief Executive Officer]

It's hard to gauge what the long-term effect would be of the industrialization of Bionix. But this is going to have an impact and we are just counting on that right now. How much it is I don't -- I honestly can't quantify right now. But as we apply this capability to different aspects of our business we are seeing significant reductions in labor or said another way increased productivity. And we are marching along here sort of offering-by-offering, function-by-function, so we're doing this very deliberately and we started out the call centers and that will expand to other functional areas. But it's not just that it's also the whole approach to analytics and a whole set of other disciplines and methodologies to drive that. So the synergy target encompasses more than just effort. We're going to do more facilities rationalization.

We're going to continue to move our resources around the world. We're going to continue to focus on our pyramid. We've launched a major program to hire students and bring them in and interns and co-ops and a whole host of things to continue to lower our overall labor costs. We're making good progress with the Talent Cloud and we got 7,000 subscribers. So we're now publishing tasks or jobs or components of projects and putting that out to not only internal employees but to the external world. That will expand. That creates less friction and provides a highly value skills at lower cost. So you need to add those things altogether and I think of it more of an integrated program to continue to drive these synergies as we go forward. Does that help?

[Operator]

Thank you. We'll take our next question from Bryan Keane with Deutsche Bank.

[Bryan Keane, Deutsche Bank]

I just wanted to know about operating margins for GIS and for GBS. Just how we think about those throughout the year? Will they improve year-over-year each quarter as we go through the year? And then secondly, on the investments I know we're talking about $200 million and $250 million, just curious exactly what those investments are going into, and should we think about that as an annual expense in the business so even beyond this fiscal year that's something that's kind of necessary to keep the investment going into business?

[Mike Lawrie, Chairman, President and Chief Executive Officer]

Yes, listen, we are -- we concluded this year towards the high-end of our range on the margins and as I said in my commentary that was a reflection of doing better in the synergy arena than what we had originally forecasted. We also saw less in dissynergies on the revenue side and we still expect to see some of those dissynergies on the revenue side and as we just talked about for the previous question, there're some additional cost synergies. But I'd say those margins will over time continue to increase. But the key point here is we are investing back in the business. So this is not just about taking costs out. We are continuing to invest in our Bionix program and we'll spend tens of millions of dollars in that program this year.

We are continuing to invest in our offerings, our digital workplace offerings, an example is gaining a lot of traction in the marketplace. We're continuing to invest in cyber. We're continuing to invest in analytics. So another investment area is the investment we're making with our partners, beginning to move some of our industry IP to different cloud platforms with our partners. So we moved some of our healthcare IP platform to Azure for example. We're making investments in IoT. We're making investments in Blockchain. So these are all areas of our offering portfolio where we're going to continue to make investments because we're seeing a return, we're seeing a return in terms of increased sales and revenue.

And in terms of other areas where the other major investment we're making is in our people. And we're continuing to invest very heavily in the re-training and re-skilling of employees, particularly those that want to re-skill and prepare themselves for the opportunities that marketplaces present. So, those are the three primary areas that we're continuing to invest in.

[Paul Saleh, Chief Financial Officer]

And Bryan I think in terms of the margin on the GBS side I think we would expect them to be in the high double digit to 20% starting a little bit lower in the first quarter and then moving on throughout the year because we have some seasonality typically in our GIS margins and the post separation is on somewhere in the -- between the 13% to 16% and I think again it will be growing reflecting as some of these margins also reflect the investment that we are making in the business. Now that's I hope answer your question.

[Operator]

Thank you. Our next question is from Arvind Ramnani with KeyBanc.

[Arvind Ramnani, KeyBanc]

When I look at the last year and certainly we have been busy with kind of some of the cost cuts and of course the USPS spin and when you look into the next like 12 to 18 months I mean you outlined some of your priorities but kind of can you more broadly outline what some of the major priorities are and in particular can you talk about some of the work that we will be doing that's going to drive revenue growth or are you going to be looking to do some larger deals?

[Mike Lawrie, Chairman, President and Chief Executive Officer]

Well I would say all of the above. So our fundamental priorities as we look out at over the next 12 to 18 months is when we want to continue to drive productivity and the quality of our service delivery and it's still the major cost element in our business. And the degree that we can improve productivity and continue to see improved service levels that has a enormously positive impact on our business. Our customer satisfaction -- I said this in my commentary, our customer satisfaction actually went up. So in the first year of integration all we did customer satisfaction continued to increase. So continuing to drive our cost structure and the productivity and improve service delivery is an absolutely critical objective as we look out.

Digital, so yes we are making huge shift in our digital offerings. I have chronicled thus, I have shared with you what the growth is. We are beginning to change our route to market in terms of investing in our large accounts to put more digital resources. Our digital delivery centers we just opened or cut the ribbon yesterday on our digital delivery center down in New Orleans. So we are continuing to make a very significant investment in digital. We're engaging our delivery teams and helping us drive growth to our delivery teams. It's something we call our delivery led growth initiative.

And then of course the other priority is to continue to focus on our workforce management and this includes our ability to more accurately predict what skills we're going to need, how many we're going to need, how we source them. I just talked about the dynamic Talent Cloud, that's a whole different way of sourcing skills and capabilities, how we onboard people, how we retain people and how we are able to move them around from project to project. So workforce management, the re-skilling of our people is a key priority, our whole digital initiative as we continue to want to increase the percent of revenue that we get from digital to offset the natural headwinds we have in the ITO business, some of the other legacy businesses and then continue to focus on the quality of delivery and the productivity of delivery. So that's how we're driving growth, that's how we're driving the cost envelope and we're always looking opportunistically for acquisitions that would align with the strategy that I just outlined and as we've done the past years make those type of acquisitions, and I expect that that will continue.

[Arvind Ramnani, KeyBanc]

And one quick follow-up. Looks like you're making good progress internally on automation and AI, are you able to take some of these solutions to your clients to actually drive revenue?

[Mike Lawrie, Chairman, President and Chief Executive Officer]

Yes, you bet. I mean that's really the whole strategy is -- we just had our global customer advisory board and that's exactly what we're doing, we closed another deal today and it's part of the same exact framework. We go in, we know what this automation and analytics and other capabilities that we have. We know we can lower the cost of the existing infrastructure, we know that. Okay. Then what we do is we say -- and here are ways that you Mr. Client can reinvest in your business with our other offerings like our application modernization, or cyber or analytics or other things and that is the strategy.

Help free up the money through a simplified, more productive IT infrastructure, use those savings to reinvest in the digital platforms that help the clients on their transformation journey. That is the strategy, hasn't changed since our Investor Day. It now is beginning to get some real traction with our larger clients. And the IT industry is famous for talking about stuff years and years and years before it happens. I mean I got to tell you the Enterprise institutions around the world are now just getting to critical mass and many of these things that we in the IT industry have been talking about for five or six years. So, I think this gives us some optimism that the majority of our offerings are converging when our primary client base which is large enterprises around the world are beginning to gather pace in their own digital transformations.

[Arvind Ramnani, KeyBanc]

And just if I could just squeeze one last one in, you mentioned Blockchain a couple of times. Are there particular types of clients that you're seeing sort of more interesting and I assume a lot of the work is still a little bit early and more sort of consulting in nature?

[Mike Lawrie, Chairman, President and Chief Executive Officer]

Well I think Blockchain is a pretty pervasive technology that is going to change a lot of how transactions are done. Now just think -- our portfolio, think of insurance claims or think of healthcare claims as areas where Blockchain can be certainly leveraged. The supply chain would be another area. Where we've a lot of intermediary transactions, Blockchain it is I think going to over time eliminate or at least reduce a lot those intermediary steps in the end to end transaction and payment systems.

[Operator]

Thank you. We'll move onto Jim Schneider with Goldman Sachs.

[Jim Schneider, Goldman Sachs]

I was wondering if you can maybe provide us a little bit of color on the revenue trajectory you expect as you head throughout the year. I think Paul you referenced the back half of the year being a little bit better from a revenue standpoint. Would you expect to be executing any M&A throughout the year that could help that ultimate revenue trajectory and I guess maybe where you expect you might be from a revenue growth standpoint exiting this year?

[Mike Lawrie, Chairman, President and Chief Executive Officer]

Well as I -- I'll let Paul answer, but as I said we will do some more acquisitions that I can tell you. I mean we have a pipeline of things we're looking at. Jim you know -- we just don't know when these things are going to close. They have their own sort of lifecycle. So you just -- you don't know that and most of what we do and classify more stuck-ins that are very consistent with our overall strategy of improving our digital offerings, Ebix and Sable37 are great examples of that in the Microsoft Dynamics arena.

So yes I do expect to get some help from those potential acquisitions, I just don't know when they are going to occur and I don't know what the whole year impact would be on revenue, because that's obviously time dependent.

Traditionally our revenue is a little lighter in the early part of the year and stronger in the back half of the year and we saw that this past year. So I don't -- some of that seasonality is something that's just the way the year plays out, so we would expect that as we progress through a fiscal '19. Paul you may want to?

[Paul Saleh, Chief Financial Officer]

And I think Mike you captured it, if I look at it this whole year we've seen an improvement throughout the year for first quarter and second quarter sequentially all the way through the fourth quarter. We will see a similar pattern in fiscal '19. If you look at the target that we have set out and if you take the midpoint of those targets it would be relatively flat year-over-year with a similar type of progression.

[Mike Lawrie, Chairman, President and Chief Executive Officer]

And Jim I just don't know yet, I don't know some of the headwinds. I mean we -- I don't know how Brexit is going to play out. There is some great opportunities associated with Brexit to get many of those systems prepared for Brexit as an opportunity. It will also I think -- it also has created some indecision and delay and other decisions and projects we see. We expect to continue to see some revenue dissynergies as we are in the second year here, but I don't -- I can't quantify those for you.

We see growing momentum with our partners. I mentioned in my commentary BPS offerings in our industry, IP and some of our digital opportunity. No question we're seeing some momentum in growth. I mean I haven't been on a lot of earnings calls where I could actually use the word growth for the number. So we are seeing that and we're just giving you our best estimate right now where we see things playing out. Does that make sense Jim?

[Jim Schneider, Goldman Sachs]

Yes, it does, thanks. And then maybe on the cost synergy side, you've alluded to in the past of maybe being ahead on the Bionix driving the cost of sales that you mentioned, but maybe being a little bit behind on supply chain. As you look through fiscal '19 what are some of the opportunities where you might kind of reaccelerate those cost synergies relative to how you've been progressing so far?

[Paul Saleh, Chief Financial Officer]

Yes, I think the areas where we have still a lot of opportunities will be in our contractor spend that's an area that we have made some progress, I mentioned 6% reduction year-over-year than in fiscal '18. There is more yet to be done there, particularly as we also apply our Bionix program to that segment of our spend. I do believe also that you are going to see a lot more also from our facilities, particularly in the data center arena where we have just really started. This year we have just already consolidated two of our [90 data centers. We have at least 10 in flight and more to come. So those are the areas where we see still some great opportunities.

[Operator]

Thank you. We'll now take our next question from David Grossman with Stifel.

[David Grossman, Stifel]

So Mike growth is definitely improving, although, on an overall basis, it remains negative year-over-year. Are you seeing any light at the end of the tunnel as it relates to the legacy business and perhaps you can share some of the data points that may give us a better sense of just how that legacy business is trending and whether it is actually starting to plateau?

[Mike Lawrie, Chairman, President and Chief Executive Officer]

I think the way I look at it is I look at the amount of revenue that we're getting from these new offerings. Go back to the Investor Day that we had, whenever, when we had the chance last March. So we sort of laid out some projections around our digital growth, our industry IP and BPS growth and that's largely playing out that way slightly less growth than we laid out the first year, but it's basically playing out. The other thing is we had estimated a decline in the traditional legacy businesses primarily IP, but also our application maintenance and management business and we estimated what that curve would be. Now that curve wasn't as much as we had thought.

So, what happened this year, was we didn't see the decline as rapid as we had forecasted and we didn't see quite as much growth in some of the new offerings, and that got us sort of where we were -- where we are. The other thing that we're seeing is that when we do go into a client and we help them reduce their infrastructure costs, the reduction of those infrastructure costs is usually in a shorter timeframe than the revenue that we achieve from the digital platform growth. Again I don't want to go into too many client names now, but I'll give you an example of how this works.

So, we went in and reduced the infrastructure costs, by somewhere around 10% to 15% and that we began billing at a lower rate, two or three months after we initiated the agreement and then we began to get some of the reinvestment back into the digital platforms like our application modernization and some of our enterprise cloud apps business. That revenue is now starting to flow and the account is growing, so we're now forecasting growth in that account for the first time in seven years. But there was a -- not a delay but there was an interregnum where the revenue actually went down slightly more before it went up.

Those are -- that is -- I got to tell you that's very difficult to model. Because each thing is different. The transition to a digital workplace offering might take longer than the transition to a new cyber offering. So each of these has their own time scales, and each customer plays out slightly different. So what we try to give you is an aggregate, but the overall revenue model that we talked about over the two or three year period of time is absolutely intact with what we've discussed at the Investor Day. Does that give you the color you're looking for?

[David Grossman, Stifel]

And just to follow that up then you are talking about '20 -- sorry if I missed it but do you have any plan or did you mention whether you are going to re-class that fiscal year '20 target that you laid out a year ago?

[Paul Saleh, Chief Financial Officer]

Yes we will. I think you can see already, initially our margin expectations were 14% to 15% and now we are already closer to the 15%. So it would be probably more likely the 15% to 16% if I had to make a guess now. And then the revenue I do believe is going to be fine because we were already factoring I guess sort of the USPS business was going to be in the same range of the 3% to 4% growth over that timeframe from before. So we will have an opportunity to update some of these.

[Mike Lawrie, Chairman, President and Chief Executive Officer]

And that's why we wanted to do another meeting sometime this fall, so that we can give -- update those models and make sure everybody is on the same page post the formation of Perspecta.

[Jonathan Ford, Head of Investor Relations]

So we're going to now close questions. Paul wanted to have a final comment before we close the call.

[Paul Saleh, Chief Financial Officer]

I just really wanted to make sure that as we set the targets for fiscal '19, you are at least clear on the EPS. So I just want to make sure we -- that we said that we will do $7.75 to $8.15 that's the target range that we are having -- we expect for fiscal '19. Now this is how it works out, for fiscal '18 we have reported $7.94 now if you take out the USPS contribution that's a $1.03 and there is also some stranded costs that we will have to -- we are planning to take out but we have that's about $0.20. Then do you get $7.94 less the $1.03 less the $0.20 you get to the $6.70 that I referred to. So on a year-over-year basis I want to make sure that people have the right calibration. We go from $6.70 to $7.75 to $8.15 for the commercial DXC business which is a 16% to 22% growth on a comparable basis -- on a year-over-year basis.

[Mike Lawrie, Chairman, President and Chief Executive Officer]

And with that operator we will close the call.

[Operator]

Thank you. And that does conclude today's conference. Thank you all for your participation.