Leidos Holdings Inc (LDOS) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Leidos Q3 2015 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would like to introduce your host for today's conference, Ms. Kelly Hernandez, Vice President of Investor Relations.

Ma'am, please begin.

Thank you, Vince, and good morning, everyone.

I'd like welcome you to our third-quarter calendar year 2015 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 October 2, 2015.

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 for the third quarter, and our expectations for the future.

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

During this call, we will make references to year-over-year comparisons.

Due to the previously announced change in our fiscal year, we will be comparing our just released Q3 calendar 2015 results for the quarter ended October 2, 2015, with our previously reported Q3 fiscal 2015 results, which represent the three months ending October 31, 2014.

During the call, we will also make forward-looking statements to assist you in understanding the Company, and our expectations about 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.

Finally, 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 supplemental information on our Investor Relations website.

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

Thank you, Kelly.

And thank you all for joining us this morning for our third quarter calendar year 2015 earnings conference call.

We are pleased with our strong financial results both in the quarter and the year-to-date.

Our third quarter performance continues the momentum we have been building in our business all year, with another quarter of solid operational performance and financial results that exceeded our expectations.

We had a strong level of profitability in our National Security Sector, robust revenue growth in our Health and Engineering sector, and we generated a significant amount of cash flow from operations.

This outstanding year-to-date financial performance enables us to increase full-year 2015 guidance for revenues, non-GAAP earnings per share and cash flow from operations.

While delivering these financial results during the quarter, we also built up our backlog nicely with a book-to-bill of 1.19.

As you know, the third quarter is a seasonally strong quarter for bookings, due to the end of the government fiscal year.

This year, we saw a more typical effect from the government's year-end procurement activity, which was an improvement over last year's more modest pickup.

The overall market has improved and if recent news regarding the likely passage and signing of a budget and debt limit deal in fact becomes a reality, this would diminish the likelihood of a government shutdown.

While near-term outlays are based on the minimal budget growth of the last couple years, the increases suggested in this deal in defense and domestic budgets in fiscal 2016 and 2017 would bring a real lift to the market both in terms of predictability, as well as real growth for our industry in future years.

I know those of us in leadership positions in our industry will be doing everything we can to ensure this deal comes to fruition.

While the budget process resolves, we continue to focus the company around its core capabilities, in order to drive profitable growth.

We intend to achieve this through a commitment to streamline our offerings, improve our cost efficiency and increase our win rates.

One notable action during the quarter from a streamlining perspective is the agreement we entered to accelerate the sale of a parcel of land and buildings that we own in Northern Virginia that were part of our former headquarters.

We anticipate that this will not only drive additional cash flow, but also lower our ongoing facilities' operations costs.

We have more to go on real estate portfolio rationalization, as well as broader cost reduction initiatives aimed at maintaining our competitiveness and expanding our margins.

We are making steady progress on standing up our two large programs; the LCST program with the United Kingdom Ministry of Defense and the DHMSM healthcare records systems program with the Department of Defense.

I recently had the privilege of participating in the groundbreaking ceremony for our fulfillment center in Donnington in the UK, hosted by the Ministry of Defense's Minister of Procurement.

This center is instrumental to extracting the efficiencies we believe are possible in the MoD's Logistics and Commodities operations.

And this groundbreaking is a key milestone on our roadmap.

The fulfillment center covers an area the size of 10 football pitches and includes two warehouses, offices, and other infrastructure required to fulfill its critical function for the customer.

I come back from this trip with high confidence that we are well engaged with our customer and are diligently performing to our commitments, while monitoring potential risks.

On DHMSM, we held the contract kickoff conference during the quarter, which had tremendous interest and was attended by more than 600 people, including senior DoD officials.

The program team has been working closely with DoD clinicians to establish the system's baseline, are in the process this week of completing the final requirements review with the customers' program office.

We're off to a good start, but still have a lot of work ahead of us.

Beyond these large programs, a few recent wins I'd like to highlight are -- a $6 billion multiple award IDIQ contract by the US Defense Intelligence Agency to provide enhanced solutions for information technology requirements; a $950 million multiple-award IDIQ prime contract by the US Air Force to perform architectural engineering services for a range of global programs; a $900 million multiple-award IDIQ prime contract by the US Army to provide medical product and research development to the US Army Medical Research and Material Command.

These highlights are just a few examples of the recognition our customers have given us for the innovative technical solutions we are bringing to their most critical missions.

Our commitment to our customers' success in solving problems of national importance remains steadfast as we pivot the organizations towards growth.

I'm extremely proud of the work of our employees, which resulted in strong financial performance during the quarter.

I'm excited about the continued momentum I see in our efforts to expand our served markets, improve our business development results, and drive growth.

Now, for more details on the quarter and guidance, let me hand the call over to Jim Reagan.

Thank you, Roger, and thanks everyone for joining us on the call today.

We are pleased with how the year is progressing and notably our strong financial performance during the quarter.

Roger previewed some of the highlights and I join him in commending the strong efforts of our employees in this successful quarter.

Consolidated revenues for the third quarter were $1.3 billion, up 2% from prior-year levels.

This is the first quarter of year-on-year growth we are seeing in more than two years and we are optimistic that this will continue.

Non-GAAP operating income during the quarter was $98 million, representing a margin of 7.5%, up from $89 million or 7.0% margin in the prior-year period.

Non-GAAP operating income in the quarter excludes the effect of a $4 million impairment charge in our Health and Engineering sector to write off the remaining carrying value associated with the Vitalize and maxIT customer relationship intangible assets.

During the quarter, we also incurred an $11 million bad debt expense, which negatively impacted our non-GAAP operating margin by 84 basis points.

This charge reflects our anticipated collection related to the Gradient engineering construction project completed in 2013.

Absent the effect of these two items, the improved operating margin versus the prior-year period is due predominantly to very strong margins in our National Security Sector and a net profit in our Corporate segment.

Non-GAAP diluted EPS from continuing operations was $0.71 per share, up from $0.65 in the prior year as detailed on slides 17 and 18 of the investor presentation on our website.

This earnings improvement was predominantly driven by operational factors, notably strong program performance and cost controls in our National Security Sector.

Weighted average share count declined by 1 million shares versus the prior quarter, due to a full quarter's effect of our $100 million accelerated share repurchase announced on May 20.

Operating cash flow generated by continuing operations was very strong and better than expected in the quarter at $269 million.

The largest driver of the upside here was in working capital as we enjoyed better than expected payments from our government customers at the end of the fiscal year.

In addition, we continue to work on faster billing processes, which have had a strong impact on DSOs.

DSOs ended the quarter at 59 days, down eight days sequentially.

While we continue to extract efficiencies from our collections process, we would consider this DSO level the low point for the year, ahead of an expected seasonal uptick of approximately five days into the fourth quarter.

We exited the quarter with a sizable cash balance of $635 million.

We remain committed to our capital deployment philosophy.

And as a reminder, after payment of the dividend, we consider three options for deployment of our excess cash.

In no particular order, investing for growth, and this can be organic or inorganic, managing our financial leverage, and returning cash to shareholders.

Earlier this quarter, we announced that we are shifting our dividend payment calendar to align with our recently revised fiscal year-end.

The effect of this is that subject to Board approval, we will actually pay five dividends in this calendar year and then resume our normal cadence of four quarterly payments next year.

Additionally, subsequent to the end of the third quarter, we made additional debt repurchases and continue to view opportunistic debt buyback as an option for deployment of our cash.

Shifting to our business development results, we benefited from strong government fiscal year-end activity, which resulted in bookings of $1.5 billion during the quarter, for a book-to-bill of 1.19.

This compares to 0.94 in the year-ago period.

We ended the quarter with $10.5 billion in total backlog, including $2.8 billion which was funded, giving us well over six months of forward revenue coverage.

The value of bids outstanding at the end of the third quarter was $11 billion, down 32% from the prior year period, largely due to the award of some large contracts over that timeframe, including LCST.

Let me now turn to our sector results for the third quarter.

First, in our NSS or National Security Solutions sector, revenues decreased year-over-year by $28 million or 3%.

During the quarter, Overseas Contingency Operations or OCO funded work continued to wind down in line with our projections.

When adjusting for that, we experienced our second consecutive quarter of year-over-year growth in our non-OCO-funded businesses.

Now that we have more clarity regarding the budget negotiations and a diminished risk of a government shutdown, we believe that we have turned the corner to growth in NSS.

Beyond this encouraging sign, the real highlight in NSS in the quarter was its profitability, with an 8.9% operating margin, up 100 basis points from the prior year.

The higher than typical level of profitability in NSS is due to cumulative profit adjustments on several contracts due to our focus on program execution, coupled with strong cost controls.

National Security bookings for the quarter were $923 million for a book-to-bill of 1.05.

This represents an improvement over the prior year's 0.9 level, another reflection of the heightened level of activity with our customers at the end of the government fiscal year.

Now on to Health and Engineering or HES.

HES revenues for the third quarter were $418 million, an increase of 12% from the prior year.

This strong year-over-year performance was driven by a higher level of engineering and security product revenues, partially offset by continued contraction in our Commercial Health business.

Q3 operating margin for this sector was negatively impacted by the $11 million of Gradient bad debt expense mentioned earlier.

The bad debt expense had a 260 basis point impact on operating margins in the quarter.

The revenue in the quarter was comprised of a greater portion of lower margin pass-throughs related to engineering construction revenues and a timing delay in security products revenues relative to our expectations.

Q3 operating margin, as reflected on slide six of our earnings presentation on our website, also includes the impact of $4 million of impairment charges related to the write-off of the remaining amount of intangible assets associated with our prior commercial health acquisitions.

This was triggered by a reduction to our forecast for this business, as improvements in sales and profitability have taken longer than anticipated.

We remain committed to improving profitability in this business and are making changes in management, sales strategies and cost profile to do so.

When adjusting for the bad debt and impairment charges, Q3 operating margin for the sector was 6.7%.

Bookings for the quarter in our Health and Engineering sector were very strong at $624 million, resulting in a book-to-bill of 1.49.

This represents a significant improvement over the prior year's 1.0 level and is largely attributable to the government year-end procurement activity as well as the first DHMSM task order award.

On to our Corporate sector, during the quarter, we had a net profit of $3 million in the Corporate sector.

This is better than our normal run rate, driven primarily by the settlement of a legal matter, which we had previewed last quarter and positively impacted the Corporate sector profitability by about $8 million.

Now moving on to guidance.

In recognition of our strong year-to-date performance and the reduced risk profile into year-end, we are raising our full-year guidance for revenue, non-GAAP diluted earnings per share and cash flow from operations.

We now see revenue in the range of $4.95 billion to $5.1 billion for the year, up from our prior range of $4.8 billion to $5.0 billion.

We expect non-GAAP diluted EPS in the range of $2.65 to $2.80, up from our prior range of $2.40 to $2.60.

We're also raising our guidance for cash flow from operations to be at or above $300 million, up from our prior estimate of at or above $250 million.

Our updated cash flow guidance assumes a seasonal five-day increase in DSOs at the end of the year.

Our guidance also embeds a tax rate for the full year estimated at 33%, below our normalized run rate of approximately 38%.

We expect the corporate segment expenses for the year to be approximately $25 million, down from our prior indication of $35 million, due to a combination of factors including lower costs in portions of our indirect operations.

In conclusion, we are pleased with our performance thus far in the year.

We continue to streamline the company around its core competencies and resolve legacy issues in order to enable our employees to focus on addressing the needs of our customers and growing our business.

We remain encouraged by the improved climate in our end markets and most significantly by the contributions of our employees to position Leidos and our customers for future success.

With that, operator, let's now open it up so that we can take some questions.

Thank you.

Our first question is from Cai von Rumohr of Cowen and Company.

Your line is open.

Yes.

Thank you very much.

Just a quick detail, how much was the loss embedded in operations from Plainfield in the quarter before you sold it?

Thanks for the question, Cai.

The loss from Plainfield was zero for the quarter.

The transaction had been effectively completed early in the quarter and there wasn't any material loss from the deal.

Got it.

And then, so, you now have even more cash.

What will prompt you to move?

You obviously have a number of opportunities.

I think you laid out the alternatives, but when and under what circumstances might we expect to see you guys actually act on any of those potential uses of cash? &&&

Well Cai, we have been -- and I'll just remind you, we're going to pay a fifth dividend this year, which should be nice for our shareholders.

We're back in the debt market, as Jim commented.

And then we'll repeat what we have said in the past, we'll meet with the Board and the Finance Committee and we'll look at all the opportunities we have to deploy the cash to create value for the shareholders, with the dividend and preserving the dividend always being our first priority.

I have said on prior calls, I am continued to be impressed by this organization's ability to take EBITDA and convert it to cash, and if we're successful in selling the building in McLean, there will be some more cash.

And we've acknowledged, we have a higher cash balance than we need from normal operations.

So, as we approach the year end, we're going to sit down with the Board and talk about more aggressive ways to use our cash to drive growth.

Terrific.

And one just last technical question, what sort of effective tax rate are you assuming in your guide for the year?

For the full year, Cai, we'll be at around 33%, and as we said just a couple of minutes ago, we're looking at kind of a normalized tax rate beyond that of around 38%.

Terrific.

Thank you.

For next year.

For next year.

Yes.

Yes.

Thank you.

Thanks, Cai.

Our next question is from Jon Raviv of Citi.

Your line is open.

Hi.

Good morning, everyone.

On the cash flow guidance, I was wondering if that tax refund was in the original cash guide.

And related to that, what are the one-time items helping or hurting 2015 that should not repeat in 2016?

Are you able to quantify them?

Thanks.

I guess the way I would have you think about this in terms of how you'll model it for the future is, and answering your question first about that tax refund.

We did have a tax refund in the guidance that we gave you last quarter.

But the tax refund came in one quarter earlier than we expected, so that is partly responsible for a really, really great cash flow quarter.

The kind of things that I would suggest that you not model for the future is lower than normal tax rate.

The second thing is, now that we're down to -- we're getting very close to an optimal DSO for this business.

We're down at 59 days at the end of Q3.

We've suggested that you figure on an uptick of around five days for Q4.

The other things that are going to happen in the fourth quarter include some employee benefit plan payments.

So but again going forward, I would suggest that you think about cash flow as having a relatively stable DSO at the end of next year, compared to Q4 this year, and very lean amount of CapEx.

So --

Right.

So just to wrap up, cash flow growth mainly driven by net income growth going forward.

That's correct.

Okay.

And then for Roger, you're talking about, as approaching year end, thinking of more aggressive ways to drive growth.

Could you just add a little more color to what you mean by investing in the future growth?

I mean perhaps the end markets where you want to grow, how large a business you'd be able to take on and integrate?

And then especially, how do you think about the risk and opportunities between organic and inorganic growth?

Our first move is to spend money internally with customers and capabilities that we have to expand our offering.

And that can mean capitalizing some projects and using our balance sheet as a way to do that, without using our balance sheet as we did in the old EPC business where we were taking on balance sheet risk in the business.

But it's much more around R&D spending and special test equipment and things that we can capitalize that immediately support our product and product development.

And then in the M&A market, we've talked about this over the last year and a half.

We have a pipeline, we've reestablished that since I came onboard and Mike Leiter and his team.

We look at, I think, a robust deal flow.

To-date, we have been a net seller rather than a buyer.

And so, as we've said before, we're looking for capabilities that enhance what we do in sectors we're already in, with customers that we already know.

And we have not found anything out there for which the price and the quality of the property was commensurate with our view of growth going forward.

And as such, we have done an ASR.

We bought back debt, and we made a decision to accelerate our dividend so it's in sync with our new fiscal year.

And internally, we look at things because like, can we prepay some expenses.

We've talked a lot about our real estate portfolio and spending some restructuring dollars to be able to more aggressively move out of real estate property that we don't need, all that would fall to the bottom line.

So we just continue to look at the market.

And when we find something that we think creates long-term value for our shareholders, then we'll act.

And in the last year and a half, we have not been able to do that.

Thanks guys.

Thank you.

Our next question is from Edward Caso of Wells Fargo.

Your line is open.

Congratulations.

Roger, do you have your team in place?

There's been a lot of top-of-the-house turnover the last 18 months.

And is the team ready to set now or is there more to go here and are you comfortable with the team you have?

Thanks.

Yes.

I'm really comfortable with the team that we've got.

By the way, we're always looking for great people who want to join the company.

But I'm very, very comfortable with the leadership team and the team that we have out in the operation.

And it's really that group of individuals that have delivered on the quarter.

And I think we're all focused in the right direction to keep our costs where they need to be and then focus on our business development pipeline and to bring in new wins, so I'm very comfortable.

My other question is, the historic company had a bias towards sort of creative solutions technology, R&D, and so forth.

How much of your go-forward work will be linked to some sort of special, sort of higher end solution and how much will be just sort of the normal service-oriented opportunities with the US government?

Thanks.

Yes.

We've continued to increase our R&D spending, both out in the operations and some essentially directed special R&D that Gulu Gambhir, who is our CTO, is administering to really focus on innovation.

So, we've always had a mix of kind of the old science to solutions and trying to do some really new innovative stuff.

And if we could take you inside some of the fence lines and show you some of the really amazing things that we do today that is very much alive here.

But where we find ourselves in this space, we do some work that people would view as probably lower tech, but that just comes with the business.

We like to provide a broad offering to our customers.

And so, we won't turn down what looks to be providing cleared programmers to a particular customer, as part of a broad offering because at that customer, we're also developing a really advanced capability that is mission-aligned and helps them do some things that are just, frankly, fantastic.

So, you're going to continue to see us in a broad offering.

Great.

Thank you.

Thank you.

Our next question is from Michael French of Drexel Hamilton.

Your line is open.

Thank you.

Good morning.

Congratulations on the strong performance.

Thanks.

Hi, Michael.

First question, last call, there was a lot of talk about the ISR business and how well things were going there.

And I'd just like to get an update, are the trends continuing?

And I assume a budget deal will continue to aid in that area.

But if we could just get a general update on that side of NSS.

Thanks.

In that particular business, I'm always challenged by what I can say and what I can't say.

We've had a key customer come back to us for a historically strong capability that we've provided them in the past.

And we've expanded that particular product offering with this customer.

And I think we're really seeing that across the board.

What was particularly exciting is, new work on old contracts, especially as we approach the end of the fiscal year.

We saw a lot of whitepapers get written and task orders get funded in that area.

We all know that the world continues to be unsettled, and the need for ISR in the customer set is only on the increase.

And we find ourselves on the leading edge of that, and therefore, we've benefited from what appears to be a continued volatile global environment.

Okay, thank you.

And then second, on the real estate portfolio review, again, what should we be expecting here in terms of timing and what does the market look like?

And is there anything else in your portfolio review of HES that we should be keeping an eye out in the next quarter or so if there might be any changes?

Let me give you sort of a top-level strategic view of that and then I'll let Jim talk about numbers.

First, the largest real estate transaction that we have contemplated is, the one that we've already announced, we put the 8-K out.

When I got here in July 2014, we were at 220 sites, we're down to only 190, which may not seem like a lot, but for this company that loves to be forward deployed and close to the customer, it's a big change.

We continue to aggressively look at our portfolio.

We're about 15% owned and about 85% leased.

And so that usually means we have to wait for the lease to expire or we pay lease breakage costs.

And on a quarter-by-quarter basis, we look at our options to accelerate our cost savings and the comment I made earlier, we may spend some of our cash in the fourth quarter to accelerate our real estate portfolio rationalization process.

And then other things I think your comment was about, are we done with portfolio shaping.

First of all, I think, you'll never be done with portfolio shaping, there's always a look that we're taking at the assets that we own.

I would say generally on large transactions, most of that is done.

We did mention we've essentially resolved the Gradient issue for those of you who have followed us for a while and we took the $11 million on the receivable from Gradient really to just wrap that up and get that one behind us as we did Plainfield last quarter, but I don't see anything out there that's more than double-digits.

Jim.

Yes.

So, getting back to your question about real estate.

The Tysons property that we've already talked about, we're right now sorting out what that tax impact of that transaction will be, but the number when we've sorted it out, I would say it's going to be pretty sizable, and because this is part of a broader real estate restructuring program, we're going to take that significant gain and we're going to non-GAAP that out.

So our guidance doesn't include the impact of that gain nor does it include the impact of some costs related to that same program in Q4, as well as our future quarters; if we have any additional restructuring costs, we'll also be non-GAAPing those out.

But as Roger alluded, going forward we're looking at roughly 15% of our real estate will be owned.

We don't necessarily want to be in the real estate business and opportunistic sales like this as a way to further help our balance sheet out, we'll always be looking at them.

Okay, very good.

That's helpful.

May I ask one more question on HES?

Sure.

Okay.

On DHMSM, I know it's early, but one of the issues is what the revenue split is going to look like between you and all your partners, and since you've had meetings and you've had a little while to discuss this, I wonder if there's anything else you can say on that at this point?

Let me give some color and then I'll ask Jim.

First of all, it's not a revenue split.

So if I could visualize for you, we are the prime contractor.

So all of the activity on the Defense Health program will flow through Leidos, and then below us we have -- actually it's like 35 different companies, we have four or three that we kind of view as major; Cerner, Henry Schein and Accenture and we haven't specifically disclosed what the work share is underneath us, and in fact some of that will change over time depending upon the statement of work.

But I think everybody understands we're buying Cerner's EHR system, Henry Schein's Dental System and Accenture is helping us do training and deployment.

I think that's about as much detail as we provide.

One other thing to mention Michael, the value of that contract that the customer disclosed was close to $4.5 billion.

We have not put that in our bookings number.

We have not put that in our book-to-bill number, except for the value of the task order of $98 million that we've booked on that.

So our policy on backlog and bookings is pretty conservative.

This is a single-award IDIQ, there is no one else on it, but that notwithstanding, we've got a policy that says that until the task orders under this single-award IDIQ are let, we're not going to record bookings or backlog on it.

So that is one of the things that I think was an open question from someone else that I wanted to make sure we cleared up.

Right.

Very well, thank you.

I appreciate it.

Thank you, Michael.

Thank you.

Our next question is from Jason Kupferberg of Jefferies.

Your line is open.

Hey guys.

This is Amit Singh for Jason.

I just quickly wanted to check on your expectation for revenues between both the segments NSS and Health and Engineering, especially Health and Engineering, this quarter you saw higher sales volume because of engineering and security product business.

And security product business, I think could be a little lumpy on a quarter-over-quarter basis.

So, how should we look at fourth quarter growth between the two segments?

Was there some pull forward of revenue in the Health and Engineering segment in the third quarter?

Well, the third quarter was characterized by a couple of programs that grew with some additional change orders in the engineering piece of the business and at the same time, we had some expectation of some product sales that got delayed into the fourth quarter.

So I think that if you're thinking about Q4, you can think of maybe a bit of an uptick in profitability and some incremental revenue in Q4 relative to the NSS segment which should be as we said and you will see this in the Q as well, we did take some profit write-ups as we visited EACs on programs in Q3.

Those programs are going to continue to run strong, but not have that cumulative profit impact in Q4.

So, just to kind of wrap it up, I think that the way you would think of is more normalized revenue and profitability in NSS and then in HES, you might see a bit of an uptick in the fourth quarter relative to the product sales.

All right.

Perfect.

And then staying on HES again, how do you think about this business sort of going forward.

You guys are -- and especially, as you relate that to your M&A, if you're looking at size perspective, you guys might be at a slight disadvantage, especially in the commercial side, because of the smaller size.

So for M&A, does it make sense to bulk up this segment or become more competitive in the market.

Or over time, do you guys see Health and Engineering as a percent of your overall revenues decreasing and you bulking up on the NSS side?

Well, great question.

And as you can imagine, these are the discussions that we have with the team and with the Board.

Let me just make a couple of points that I think will help you.

We see in health commercial and civil and government just becoming intertwined.

And we're using a commercial EHR package to provide healthcare records for active military.

And I think that's if you will, if there was ever a cross over, that is probably it.

The Affordable Care Act is going to bring us all into a very regulated government-funded healthcare environment.

So, our strategy is built around having to be able to work in all three areas.

And we like that market over the long term, it's got the characteristics that we like, it's technology-based, it's regulated, it requires customer intimacy, all those things that that we do well.

And by the way there is a layer of cyber security on all of this which really fits in our wheelhouse.

So with DHMSM, we are growing that business.

In our pipeline of M&A, are there companies in the healthcare space?

Sure.

Have we bought any to date?

No.

Because we just haven't found anything that fits our view of strategy.

I think we said over the long haul that being in the design build business is something that we continue to think through.

However being in infrastructure, smart grid, some of the oil and gas markets where we have traditionally been, we view those as very solid markets and places that we're very comfortable with and we want to grow.

And to your overall question, we like the balance that we have.

We would like to be balanced maybe even better.

We're about two-thirds, one-third, and that's okay.

I don't feel like we're compelled to do anything immediately to gain better balance, but we like the fact that we have businesses in more than one sector and we expect to maintain that and over the long haul continue to try to gain that balance.

All right.

Perfect.

Thank you.

Thank you.

And our next question is from [John Lauwin] of Stifel.

Your line is open.

Thank you, gentlemen.

First question I have pertains to the OCO numbers.

You reported $20 million in revenue this quarter.

I'm just wondering is this going to be the more sustainable rate going forward?

I'm sorry, could you repeat the question?

Oh, no problem.

So you reported this quarter that OCO revenue was about $44 million, half of what it was last year.

What's the current trend right now on this revenue, will we see it flatten out around $44 million going forward?

Yes, I think that what we said last quarter and I think the answer is the same this quarter is that we think it's settling in at a little under $200 million annualized.

The impact of the latest budget negotiation might actually have that ticking up a bit particularly given the sources of funding for some of the ISR work that Roger was talking about just a few minutes ago.

So I think that we're now viewing there to be a little bit of upside in the kind of work that has been funded under the OCO budget.

Okay.

Follow up is more regarding commercial healthcare, trying to get a better sense of the numbers here.

We have commercial health declining year-over-year.

Just curious is it sequentially declining as well?

It has had some sequential decline, but as we said in the call, we believe that the steps that we've recently taken in terms of enhancing the sales force, the sales compensation models, as well as continuing a pretty robust product offering that is vendor agnostic, will continue to keep us in the, what we believe is the number one spot among our peers.

The point and our real focus is getting back to growing our share of that market as opposed to having that shrink sequentially.

Okay.

And lastly, what's the remaining risk around your past renewable power plant programs.

Is there anything that we haven't really covered?

No, I think we've been pretty clear.

So the transaction is closed.

And we have no care or custody or control.

We took a fair amount of that in cash, but we also took a note, which is secured by the power plant, which comes due in two years, although it can be extended for three years after that at an increasing interest rate.

We believe the note is over secured by the physical assets and the assets frankly are secured by the power purchase agreement, which makes the whole renewable power plant process work.

So, and Greenleaf, who was our buyer, is a longtime operator and owner of renewable power plants and this is in their wheelhouse.

So, yes, there is operations and credit risk through the note, but we're very, very comfortable with our position.

And, frankly, Greenleaf has been doing a great job of bringing their expertise to the plant and operating it, so we would tell you that it's minimal.

All right.

Thank you gentlemen.

Thank you.

At this time there's no other questions in queue.

I'd like to turn the call back to Mr. Roger Krone for any closing remarks.

Great.

Well.

Listen, it was a real strong quarter, hard work by everybody on the Leidos team, really a return to focusing on the customer and creating value, making sure that we're keeping our costs in control, and then the whole organization is in this pivot to make sure that we're calling on customers, understanding what their needs are and creating value for them.

We know that returning value to our shareholders is why we're here.

We've realized that we ended the quarter with a little bit more cash than even we thought that we would because we had an accelerated tax refund payment and because of that we've been able to do some great things, like accelerate our dividend and we're going to spend some money in the fourth quarter to help us with operations and reduce our cost.

But the team is in place, I'm really pleased with our quarter and we look forward to talking to everybody next quarter.

So thanks and have a great Halloween.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes your program.

You may now disconnect.

Everyone have a great day.