Leidos Holdings Inc (LDOS) 2016 Q3 法說會逐字稿

Welcome to the Leidos third-quarter 2016 earnings results conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Kelly P. Hernandez, Vice President of Investor Relations.

Thank you, Ms. Hernandez, you may now begin.

Thank you, Rob, and good morning, everyone.

I'd like to welcome you to our third quarter 2016 earnings conference call.

Joining me today are Roger Krone, our Chairman and CEO; and Jim Reagan, our Chief Financial Officer; and other members of the Leidos management team.

Today, we will discuss our results for the quarter ending September 30, 2016.

Roger Krone will lead off the call with comments on the market environment and our Company strategies.

Jim will follow with a discussion of our financial performance and our expectations for the future.

After these remarks from Roger and Jim, we'll open the call for your questions.

Today's discussion contains forward-looking statements based on the environment as we currently see it and as such, does include risks and uncertainties.

Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially.

Finally, during the call, we will discuss GAAP and non-GAAP financial measures.

A reconciliation between the two is included in the press release that we issued this morning and is also available in the presentation slides.

The press release and presentation as well as the supplementary financial files are provided on the Investor Relations section of our website at ir.leidos.com.

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

Thanks, Kelly, and thank you all for joining us this morning for our third quarter 2016 earnings conference call.

I want to especially welcome those that stayed up to watch the end of the baseball game last night.

In Cleveland, we had the final and decisive seventh game of the baseball championship.

Congratulations to the Chicago Cubs for their late-night extra inning win and to the Cleveland Indians for making it one of the most exciting game sevens ever.

Truly, a year of the underdog.

Onto the call.

I'm pleased with our results for the quarter.

Our focus on executing the business during the acquisition process enabled us to deliver record quarterly earnings, continue organic growth and strong cash flow.

We successfully completed our acquisition of Lockheed Martin's former IS&GS business on August 16.

This transformational combination has already begun to deliver on the promises that we saw.

The quality of the people, commonality of values and commitment to our customers have improved our ability to compete for prime positions on new, larger programs.

At the same time, both legacy Leidos and IS&GS have already begun to submit bids based on the lower-cost structure enabled by the acquisition.

The experience we have had as a combined entity over the 2.5 months since closing increases my confidence that this combination will drive increased value for our customers, our employees and our shareholders.

We enjoyed several large contract wins during the quarter, helping to drive our book-to-bill to 1.6.

Most notably, we won a prime contract for a $777 million single-award task order to support the Army Geospatial Center's high-resolution 3-D Geospatial Program.

Leidos has a long history of directly supporting US Army War Fighters through vital airborne programs.

Our selection on this contract solidifies our standing as a leader in airborne ISR capabilities.

From a macro perspective, we are continuing to see a modest recovery in our end markets.

The downturn has flattened out and outlays are beginning to tick up.

In fact, FY16 marked the first year since 2012 that DoD outlays grew year versus year.

As we expected, the new government fiscal year began with a continuing resolution.

In less than a week, we will have the uncertainty of the elections behind us -- at least we hope so, and that may give us clarity on timing and likely outcomes of future budgetary decisions.

We remain confident that Leidos is well-positioned to capture an increasing share of the budgets, as we continue to focus on solving our customers' most challenging mission-related problems.

Onto the quarter.

Consolidated revenue of $1.9 billion is up 43% from the prior-year, driven by $620 million contributed from IS&GS during the quarter.

Organically, legacy Leidos was up 5.1% from Q3 of last year, when adjusting for the prior-year period for the divestiture of the heavy construction business.

Our GAAP diluted earnings per share from continuing operations increased to $0.80 from $0.67, reflecting higher profitability offset by the amortization of acquired intangibles from the IS&GS transaction.

Non-GAAP diluted earnings per share was $1.25 in the quarter, up 71% from the prior-year period's $0.73, a record for the Company since the 2013 spin-off of new SAIC.

As we suggested on our last quarter call, we experienced a strong book-to-bill on a consolidated basis during the third quarter at 1.6.

This reflects not only a strong level of awards at the end of the government fiscal year, but also market share gains.

We can generated cash from operations of $226 million during the quarter, better than expected, allowing us in September to pay down $100 million on our term loans used to finance the closing of the IS&GS transaction.

This payment was ahead of schedule and could accelerate our timeline to a more flexible capital deployment posture.

As I indicated earlier, our integration process is going well.

Jim will provide more detail shortly but we are ahead of plan on our cost synergy timeline and delivered notable milestones in our integration activities during the quarter.

Most important, during the quarter, we added 15,000 new employees to our organization and I could not be more impressed with the level of collaboration, partnership and focus of our combined organization.

Cultural fit is often the most difficult aspect of large transactions and based upon my past experiences, I am pleased with how smoothly our cultures are combining.

I want to publicly welcome our new employees and congratulate all of our now 33,000 talented and dedicated employees on a job well done this quarter.

Of course, there is still a lot we need to do to ensure the long-term success of the acquisition, but I am pleased with the progress to date and continue to be excited about the new Company.

With that, let me hand the call over to Jim Reagan, Leidos' Chief Financial Officer, for more details on the quarter and our outlook.

Thanks, Roger, and thanks to all of you for joining us today.

As Roger indicated, the quarter results were very positive and reflected strong bookings and operating results of the combined business.

Excluding the impact of the IS&GS results and our prior divestitures, the topline grew 5.1% while the IS&GS results contributed revenue for the seven-week period that exceeded expectations.

I will get into sector results in just a moment.

GAAP operating income of $101 million is $7 million higher than the prior-year's level, reflecting the IS&GS contribution during the period, offset by associated transaction-related charges.

Non-GAAP operating income of $177 million reflects $125 million of profit from the legacy Leidos business and $52 million from the IS&GS business, yielding operating margin of 10% and 8.4%, respectively.

Non-GAAP results exclude the effect of transaction-related amortization and expenses and other items detailed on slide 14 of the presentation available on our website.

The strong operating margin of the legacy Leidos business reflects broad-based strength in our National Security, and Health and Infrastructure sectors.

I will provide more details on that shortly.

Also during the quarter, we incurred a lower-than-normal tax rate driven by a few discrete items, most notably the deductibility of the special dividend paid to our employee benefit account.

For the quarter, our effective tax rate was 4.6%, reflecting a tax benefit of $38 million related to the portion of the special dividend paid to shares held by our employee benefit plans.

Without this benefit, our tax rate would have been approximately 30% of non-GAAP pre-tax income.

Slide 16 of our investor presentation on our website provides more detail on our GAAP and non-GAAP tax provision and tax rate.

I will have more on full-year tax expectations in a moment.

Non-GAAP EPS for the quarter was $1.25 compared to $0.73 a year ago.

Non-GAAP operating income and EPS excludes the impact of integration and business restructuring costs related to our acquisition of IS&GS.

On this basis, the IS&GS business contributed about $0.07 of EPS for the quarter after reflecting the impact of the incremental shares and debt issued in connection with the transaction.

The impact of the tax benefit of the special dividend was approximately $0.10 for the quarter.

Diluted earnings per share is based on a weighted average of 114 million fully diluted shares outstanding for the period.

This reflects the issuance of approximately 77 million new shares on August 16, in conjunction with the closing of the transaction with IS&GS.

Fully diluted share count, as of the end of the third quarter, is approximately 152 million shares.

Cash flow from operations of $226 million reflects strong government year-end collections as well as some working capital timing items, which we expect to reverse in the fourth quarter.

As you can expect, our contract teams have been working with their customer counterparts to implement required contracts changes on legacy IS&GS programs that enable our bills to be readily approved and paid by customers.

This is a multi-quarter process and there's more hard work and potential impact that we have factored into our previously issued cash flow guidance.

Let me spend a moment discussing our sector results.

Our National Security sector, or NSS results, grew 4.9% over the prior-year period, driven primarily by growth in our international business.

Operating margins in NSS were strong at 9.9%, primarily reflecting achievement of contract milestones, which allowed us to record profit write-ups on a couple of programs.

Revenue in our Health and Infrastructure sector declined 21.5% due to the sale of our heavy construction engineering business in the second quarter of this year.

If you exclude the impact of the sale of that business, HIS grew 8.3%, driven primarily by the continued growth in the Defense Health Agency Genesis Program to modernize the DoD 's healthcare records system.

Non-GAAP operating margins in HIS of 12.8% during the quarter, reflects strength in our Federal Health business and the sale of our low-margin design build business earlier this year.

The year-over-year improvement in margins also benefited from the elimination of losses on the Plainfield facility and bad debt expenses on the [graidian] project which was reflected in the year-ago period.

The IS&GS business earned $620 million in revenue in the period from August 16 through September 30, slightly better than our expectations.

Now please note that for your modeling purposes, we have provided management estimates as historical revenue and operating income for IS&GS on slide 12 of the presentation appendix.

Non-GAAP operating margins in our IS&GS sector were 8.4%, consistent with our estimates and reflect some early impact from the elimination of corporate allocations and pension costs that burdened the business prior to the merger.

Today, both the legacy Leidos and IS&GS businesses are already benefiting from a reduced cost structure and those benefits of scale will increase as we continue with our integration process that will increase efficiencies and reduce costs.

We closed the quarter with excellent liquidity, with $449 million of cash on hand plus full availability of our $750 million revolver.

Our debt position of the end of the quarter was $3.5 billion, reflecting the $100 million pay down on one of our term loans that Roger mentioned.

Shortly after the closing, we executed a series of interest rate swap transactions which took advantage of the favorable market conditions, enabling us to fix $1.15 billion of aggregate term loans and an effective cash interest rate of 3.3%.

Our integration with the legacy Lockheed IS&GS business is proceeding well and on schedule.

We are tracking ahead of our cost take-out objectives at this point in the integration process and as of the end of the third quarter, we have already achieved our full-year 2016 cost-reduction target.

We have named our leadership to the second level below the CEO and have developed detailed plans and timelines for the migration of significant IT systems.

Notably in early October, we completed a major upgrade to the Dell Tech Accounting and Financial Management System as a precursor to consolidating the legacy IS&GS systems on to our platform.

This consolidation, which is planned for year-end 2017, is expected to yield significant process and cash flow improvement and enable much of the cost synergies planned for 2018 and beyond.

With more than 30% of our target annual cost synergies already achieved and our IT systems consolidation going smoothly thus far, we remain confident that we will achieve our planned cost savings of $471 million on a run rate basis by early 2018.

Now onto guidance.

As a result of the strong performance year to date, we are raising our 2016 revenue and EPS guidance while reiterating our cash flow guidance.

We now expect revenues for the full-year in the range of $7.0 billion to $7.1 billion, up from our prior range of $6.8 billion to $7.0 billion.

We expect non-GAAP diluted EPS within a range of $3.50 to $3.60 from our prior range of $3.15 to $3.35, reflecting a $0.30 increase at the midpoint.

Please note that due to the timing and magnitude of the new share issuance in the middle of Q3, the full-year EPS results for 2016 will not equal the sum of the four quarters.

The share count used for the full-year results must be properly weighted to reflect the share issuance.

We've provided some details to help you model this effect in slide 11 of the presentation appendix available on our website.

We continue to expect cash flow from continuing operations to be at or above $275 million, reflecting the largely flat Q4.

In conclusion, we are pleased with the strong performance of the combined business, and we are tracking well relative to our commitments on driving synergies from the transaction, and creating value for our shareholders.

The focus and collaboration of our 33,000 employees was instrumental in producing these results, and it gives me great confidence in the future.

So with that, Rob, let's now open it up so that we can take some questions.

(Operator Instructions)

Cai von Rumohr, Cowen.

Good results.

So first question, so tax rate for the year, where is that expected to be now?

The full-year tax rate will be about 26%.

And that reflects the non-GAAP tax rate that we had of 4.6% in Q3.

The fourth-quarter tax, rate we are expecting to return to a normalized rate of about 38%.

Got it.

Okay and could you tell us if NSS, those margins looked particularly good.

How large were the favorable adjustments?

Well, the way I would think of this, Cai, is that these favorable adjustments were really -- these were triggered on the achievement of certain contract milestones, and if we had our druthers, we certainly would have spread those.

But the number is in the 20%s.

But the thing that I would want to emphasize is that these really -- these adjustments don't change our view that normalized.

We are expecting that part of the business to move in the direction of a normal 10% run rate margin.

Got it.

Okay.

And then the last one, at HIS, maybe give us some color in terms of security product.

How is the shipment mix in the quarter, what we look for, for in the fourth quarter, and same question on the commercial health IT business?

Relative to prior quarters, the Security Products business was relatively light, which, you normally, when you see margins like this, you normally would have thought it was a big quarter for shipment.

Actually, the results were primarily driven by strong program performance in the federal side of the Health business, and this is outside of the DHMSM, or DHA Genesis Program.

So we had good contract events that led to higher award fees and a couple of good program write-ups over there.

Thank you very much.

John Raviv, Citigroup.

Should I take the lack of mention on 2017 guidance on the slides release as a reiteration or any commentary on how we're tracking those numbers you provided in early August?

No, I think you ought to take it as a -- essentially a reiteration of our policy that we would give 2017 guidance at the end of the year, like we always do.

Sounds good.

We have our Investor Day presentation that's out there and we won't touch 2017 guidance until we get through the end of the year.

Sure.

And then just going into the end of the year and just going forward, how are you accounting for the uncertainty and the integration risks when you think about your expectations going forward?

For example, what's embedded in your cash flow outlook for working capital in light of the comments you made about potential novation issues?

And then secondly how do you account for things like the Department of Energy deal going away from you, or the Genesis ramp being slightly delayed?

Okay, that was a complex question.

I will give you a top-down view and then Jim can try to provide you some details.

So, we build an aggregate plan.

We look at risk and opportunities and we did that when we put together the presentation for Investor Day.

We did that when we updated our guidance, and we build into that a reasonable view of risks and opportunities, and both good things and bad things happening.

And we come up with, I think a reasonable estimate somewhere down the middle of the road.

Just specifically on the DHA Genesis Program, I want to make sure that you understand that what we said is that, relative to revenue, we don't see the program being delayed.

What we are doing is, we're actually maturing some of the software, we are conducting some more tests, we're doing some cyber scans.

So the installation at the first facility will be a few months later than we had anticipated, but the level of activity is essentially the same and the entire program, if you think about deployment to all of the facilities within the Department of Defense, will essentially remain on track.

So we will be a little bit later on the first couple facilities, but we expect to pick that back up as we go into the implementation phase.

And John, you had asked about cash flow.

A couple things worth amplifying on that.

We -- first of all, the novation process is going well.

And so far, we haven't seen -- excuse me, any material disruption in the form of higher DSO as a result of that.

But it -- we're still fairly early in the process, and there's still a lot more work to do, as I mentioned on the call.

So to fully answer your question, we have baked in the possibility that there are a couple of speed bumps that occur as contracts that haven't yet been novated and the customers' billing office gets a different kind of bill that has to get processed specially during that novation.

So we're thinking that there might be a two- to three-day DSO bump that is factored into how we're thinking about cash flow that we previously guided to for Q4, as well as into 2017.

Sorry for the multi-part of it.

Thanks a lot.

Edward Caso, Wells Fargo.

Congrats on a great start here.

Could you talk about staffing challenges?

We hear more and more about the difficulty in finding cleared personnel with the new tech skills and cyber skills that are increasingly in demand?

That's always a challenge, especially when we are talking about maybe the Baltimore, Columbia area, where there are a lot of contractors and a huge need for computer science skills, probably a job I am particular with, what we call lifestyle polygraph.

It's just a requirement to do certain kinds of work, and we are all competing, and we are all competing for the same talent base.

We are pleased with our success.

Frankly, the acquisition of Lockheed's business creates a larger entity and more professional growth for employees who want to join the Company and I think we've already seen more interest in our recruiting activities than when we were standalone Leidos.

One way people are dealing with that is, trying to do that work away from the customer facility, and there's been some success.

That -- some of those customers -- that particular customer has some other facilities around the country, where if you have an operation there, you can move some of the work away from the national capital region.

But I think we would all admit is, it's a bit of a challenge and if you're -- have a son or daughter who's thinking about a career and is going to the University of Maryland, a computer science degree is probably a good decision.

Can you talk a little bit about bids outstanding?

Your revenue number came in actually a little light of what we were expecting, though you raised the full-year guide for 100 -- by $100 million, so is there a -- some good things kicking in quickly here?

What -- maybe some sense of the timing and why the strength expected in Q4?

Thanks.

Yes, Ed, I am not sure how you got to your number because when we put our prior guide together, the number we were thinking about relative to our prior guide was a little bit lighter than where we came in at.

But with that said, we have had some recent wins that we are expecting are going to put a little bit more run rate into the business, which is reflected in the implicit -- you know when you do the math, you're looking at something north of $2.5 billion of revenue for Q4, which is certainly consistent with, or a little bit better than the guidance that we previously issued at Investor Day.

Great.

Thank you.

Congrats.

Robert Spingam, Credit Suisse

Just wanted to follow-up on Ed's question there.

How do we think about the segments as we go into the end of the year, relative to what you just said?

And then more specifically on IS&GS in the quarter, it seems like the revenue was a little front-end weighted, given that the deal closed right in the middle of the quarter.

I think about 54% of the sales were pre-deal and 46% post.

Sure, Rob.

The -- what I would say is, let me take your second half of the question first.

The way we think about the weighting was that at the end of -- there's two things going on.

At the end of the ownership period of Lockheed, they did a lot of contract closeouts that caused a little bit of an updraft in the revenue recognized on certain programs.

Those contracts were closed out and put to bed.

That was both of revenue and profit updraft.

The second piece that I would tell you is that we had an impact.

It wasn't huge, but it was -- it had a bit of an impact on revenue and margin.

That is, due to what we call conforming accounting adjustments.

So at the closing date, we have to take all their major programs, zero the EACs out, and treat them like they are day one, and begin recognizing that revenue on the accounting policies of Leidos.

And so there was a bit of an impact there, and then we would estimate a drag on margin of less than 100 bps, but it is also a short-term drag that because of the way the accounting works, it tails off through the end -- we estimate that it will tail off through the end of this year.

It has to do with contract contingency reserves that we're not able to carryover into our balance sheet.

To answer your question about how we're thinking about segments, you know, clearly, both NSS and HES had really great quarters because of the confluence of contingency releases and contract milestones that drove a little bit above normal margins, but we're expecting them to settle back to how we have previously guided.

Now, one thing I would also point out is that, as Roger said, we have launched the design of our new organization, and we are in the midst of implementing the organization that we've previously named, and that process will be fully baked in to how we are running the business through the fourth quarter.

And at the beginning of 2017, we will have a new segmentation that will effectively distribute the IS&GS business and take the legacy Leidos business and line it up along customer market basis.

And we will have more to say about that in the fourth quarter.

Hey, Rob.

I would add -- and you can dig this out of our chart on Page 8 in the presentation is that even the IS&GS book-to-bill for the six weeks is 1.2, so it's really strong performance across all three of our reported sectors, all significantly north of 1. So really nice performance even for that short stub period that we had post-closing.

Roger, that actually dovetails right into my next question, which is, looking at your Slide 12, second quarter, IS&GS was just under $1.3 billion.

Is that the low watermark here?

You are higher than that in the fourth quarter but of course, you have the Lockheed close-outs but on the other hand, you mentioned the 1.2 book to bill.

So is pro forma organic growth at the bottom of Q2 for IS&GS?

Well, a couple things.

First, we don't guide at the segment level.

And so we're not going to give you a specific number.

We did certainly at Investor Day talk about where we thought IS&GS was trending.

And I think we indicated when we thought it would turn around and start to grow and I think we -- in generally at Investor Day, we looked at that more in 2017 than in 2016.

And I don't think we want to be more specific than that.

Other than, the whole tone of, I think the release and this call is, we have increased our confidence across the board and just feel really good about the numbers that we've got out but, we're not giving any more specificity on the segments.

Okay.

I will try one more then, but this is back on NSS.

You had the 5% growth but you mentioned it was international.

What's going on the domestic side?

And again your book-to-bills are strong so when do we see growth there, or am I asking -- basically barking up the same tree I just tried to bark up?

Well, there's a bit of barking up the same tree, but I will let Jim see if he can at least give you a little bit more information.

Yes, we did indeed say that it was international.

We've had really strong bookings in the last quarter and year to date in the domestic side.

So when you think about revenue across the sector, including international going up, and that book to bill is well north of 1, and then the quarter in the 1.6-ish range, what we can tell you is that the domestic part of NSS, that drives higher margins, has had good growth in backlog in the last quarter.

And we are thinking that, that bodes well for how the growth in the domestic side of the business will go, as well.

Okay.

Just one last clarification question.

On the $0.25 increase in guidance at the two ends, $0.07 is clearly the tax-related gain.

I just want to clarify what the rest of that is.

The rest of it is performance.

It's all performing well.

It's all performance.

Okay.

Thank you both.

Bill Loomis, Stifel.

Good quarter.

Just going back to the question on the margins for the segment because there was -- it was pretty material change on NSS, in particular.

Now is -- you mentioned some write-ups.

What was the 20%s number you gave?

What were you referring to on that?

Without being specific on programs, because I really can't be specific on programs, Bill, these were contract milestones.

These were things we were waiting to happen that enabled us to recognize revenue on some contingent events that are really milestone-driven revenue recognition.

We kind of alluded to this in the second quarter, when you might remember, Bill, we had a little bit of a light margin quarter, and that was because the -- we had some profit that was hung up in certain things happening and those things have now happened.

So when we're looking at the modeling, I mean you had mentioned trend towards 10% in the future.

I don't know if you could clarify what timeframe you were thinking about with NSS routinely getting 10% type margins but second of all, just for this year.

So we should look at second quarter as being abnormally low and then you had that reversal in the third quarter.

Are we still generally looking at roughly kind of an 8% trend in the group, or is it going to be higher?

Yes, I think 8% is a good way to think about it in the short run, but we've got -- what we said at investor day was their aspiration is to get the whole business, including NSS, closer to a 10% number and that we believe is achievable with the business mix we've got, as well as the achievement of the cost take-outs that are on schedule for this year and beyond through to the run rate in the beginning of 2018.

Okay, and then can you give some comments on the UK contract, how that's performing?

And was that one of the contracts responsible for the uptick in margin in the quarter?

Well, that contract is not a material part of the uptick in margin, Bill, but I would say that it is a complex program.

And as we continue to execute, I'd say that on balance we're pleased with how things are working.

Roger, do you have anything else to say?

Yes, let's see -- I don't want you to read into the word, complex as if we have any concerns.

Actually, the program is performing really, really well, and we have a great relationship with the customer.

The construction of the large warehouse called the defense fulfillment center is on track to be completed this year.

But it -- when we first introduced the program, we talked about the margin would grow over time and we are still confident that's going to happen and that's how the program is performing.

The team in the UK are doing a fantastic job and we've actually already started to save the MOD money.

And we're hoping that because of our performance, that program will expand even beyond our expectations.

And so it's just a terrific program and we are really privileged to have that one.

You said the fulfillment center completed this year: is that ahead of schedule?

Because I thought I heard before it was like next spring or summer?

Well, the construction will be completed this year, and then -- yes.

I don't want to dive off into a program review but the physical fulfillment center will be complete.

Then we have to get the software complete and then we have to consolidate inventory and then we have to get through checkout and things.

And so that will go on for several months significantly into next year.

But if you drove by Donnington, you would see this absolutely fantastic two new warehouse buildings, at least today from the outside, look almost complete, but there's still a fair amount of systems and fiscal buildout that has to be done between now and the end of the year.

And just on the marginal needs, I ask, obviously, good improvement here.

You mentioned the big change from year over year.

Doesn't sound like Genesis had an impact raising that margin from your description.

But how -- on the commercial healthcare business, did that have an impact on boosting the margin?

Is that improving on a revenue and profitability side on the commercial electronic healthcare records systems business?

Bill, on the commercial side, it is becoming a less material part of the business just because the rest of this sector is growing on the federal side.

But with that said, the commercial health business is performing well.

We said before that the revenue is holding well.

It's growing a little bit.

We are experiencing good bookings there and program margins are performing well in addition to that.

Okay, so it's not -- the commercial businesses isn't necessarily causing the double-digit margins and Genesis isn't either, so what is it?

Is it just true-ups on some of the non-Genesis DoD contracts?

What kind of run rate should be thinking about on margin on that business?

Well, I don't think that it changes the long-term view that we've expressed, which is in the 8%-ish.

We've said before that the DHA business is accretive to our overall health margins, okay?

And that, as I said before, the margin on that program hasn't changed and it wasn't responsible for the drive up to 12.8%.

What it is is other programs that are in the Federal Health business.

So we have a number of other programs that serve the VA and then also serve the Defense Health business.

And we've achieved some contract milestones that have brought the margin up for Q3, as well.

Okay.

Great.

Thank you.

Tobey Sommer, SunTrust Robinson.

I was wondering if you could speak to the prospects for new projects in the healthcare record space and the -- and your public healthcare business, particularly as you may be positioned relative to the VA, if they eventually move forward and decide to try to modernize their systems.

Well, we will talk a little bit, Toby, about what's going on in the VA.

But I will tell you my ability to predict the future will be a lot better a week from now, maybe.

Let's see.

There's -- I think -- let's start with the basics.

I don't think anyone would disagree that, in the near term, the VA will go through some modernization.

And I think the VA is in the middle of a study, trying to ascertain whether they continue with their, essentially, in-house legacy system, which is a MUMPS database, or they go with a, more of a commercial off-the-shelf system.

And the VA hasn't made that decision yet and I think it will be actually a considerable amount of time, maybe into the next administration before they make a decision.

With the acquisition of IS&GS, they had won a kind of a precursor to a new EHR/EMR program, which is a scheduling program and that has some potential, I think to get funded and to kick off and to be more a significant part of our VA portfolio in the future.

But we will just see how that particular program fits into the overall strategy.

And that isn't electronic healthcare records so much per se, but it is scheduling, which is one of the challenges that VA has, which is getting vets in and out of care facilities.

Thank you and sticking with this theme relative to the Genesis contract is, should we be thinking about for modeling purposes a little bit of slowdown in growth, when that enters the testing phase?

Or, is that not a big concern, given the size of the segment overall?

Okay, so we've talked to the DHA Genesis program in the past and we have said that we have to configure the software, we go through tests.

We go through some initial installations and then the customer uses the software for the greater portion of a year, and when they are to the point they are comfortable and they like the way the workflows operate and the user interface, then we move into a more aggressive deployment process.

And we still view the program that way.

We don't see, really, any change to the way it's configured.

So given what we have said in the past, this is -- there is not a slowdown.

There is not a delay.

But we did describe that there would be a -- probably a lower revenue in the next year, and then it picks up, and -- but that configuration is very consistent with the guidance we've given you in the past.

Okay.

Thank you very much for your help.

Amit Singh, Jefferies.

Earlier, you had put out a cost-saving target, I think on the gross level around $25 million in FY16, I think reaching $175 million in 2017 and then going from there, reaching $350 million in FY19.

Your earlier mention that you've already achieved your 2015 fiscal target and there is still some time to go in the year.

So is there an update there for -- especially for FY16 and FY17?

We're not ready to say exactly what the number is going to be, but it's going to be well north of the $25 million that we indicated before.

And the integration process, in many ways, got kicked off before we closed, which is how we were able to overachieve on that.

So what does that mean for our confidence in next year's target?

Obviously, if you've got a good head start, you're feeling a lot better about our ability to achieve that and to hit the numbers.

The big things that we have to do relative to achieving those targets in the coming year is system related.

There are a lot of system enablers that will enable us to reduce IT costs and consolidate operations, and those are proceeding well, very well for us and certainly on schedule, where normally you think of those as having schedule risks.

So we've done our upgrade to get this ready to begin the process of porting over the lion's share of the back-office systems from IS&GS over to what we have.

The one other thing that I would comment on where we're expecting to have a significant amount of cost savings is in real estate consolidation and those plans are also proceeding apace, so -- .

And let me just add to the color there.

First of all, we are really pleased.

We had established, what we call an integration management office, and it was certainly populated by Leidos people and folks from IS&GS, but of course, no actual integration or any actual activity happened prior to closing.

But we were able to put some fairly detailed plans in place so that the day after closing, we were able to hit the ground running, and that's really given us a fast start starting on 17th of August to achieve our integration objectives.

Great.

And then as you look at your integration plan, which involves the systems, people, facilities, if you could put a percent, of what percent of this overall integration is complete right now?

And any timeline on when do you expect to say that, okay, most of the integration is done here?

My, what a complex question.

You may be interested, we have a number that we put out of about $350 million in value capture and we've given you some numbers year to date.

You could use that as a percentage.

It's really -- it's people organization, it's systems, it's real estate.

It's just really, really complex.

There will be integration activities that occur well into calendar year 2018 and just getting some of the general ledgers brought together and some of the back-office systems.

We expect to do probably the HR system in 2017 and we will probably merge into a smaller number of general ledgers, by probably on the annual close at the end of 2017, beginning 2018.

But we could see continued activity well into 2018.

But on a percentage basis, I don't -- we don't really track it in that way and so I don't have a number for you.

All right.

Thank you very much.

At this time, I will turn the floor back to Kelly Hernandez for closing remarks.

Thank you all for joining us on our earnings call today.

We look forward to sharing more updates with you next quarter.

Thank you.

Thank you.

This concludes today's teleconference.

You may disconnect your lines at this time and we thank you for your participation.