DXC Technology Company (DXC) — Q1 2015 Earnings Call Transcript

Great. Thank you, operator, and good afternoon to everyone. I'm pleased you've joined us for CSC's First Quarter 2015 Earnings Call and Webcast. Our speakers on today's call will be Mike Lawrie, our Chief Executive Officer; and Paul Saleh, our Chief Financial Officer. As usual, the call is being webcast at csc.com/investorrelations, and we have posted some slides to our website, which will accompany our discussion today. On Slide 2, 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 these risks and uncertainties is included on our Form 10-K, Form 10-Q, and other SEC filings. Slide 3 informs our participants that CSC's presentation includes certain non-GAAP financial measures, which we believe will provide useful 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. Those documents are available on the Investor Relations section of our website. Slide 4 makes our participants aware of 2 important changes in our results presentation this quarter. First, CSC adopted a new mark-to-market pension accounting policy, which recognizes actuarial gains and losses on the fair value of pension assets each year. Paul will discuss this change in more detail. Second, CSC changed its intercompany accounting. Intercompany transactions are now treated as cost transfers and not as intercompany revenue. Finally, I'd like to remind our listeners that CSC assumes no obligation to update the information presented on the call, except, of course, as required by law. And now I'd like to introduce CSC's CEO, Mike Lawrie.

Okay, thank you. Good afternoon, and good evening, everyone. As usual, thank you for your interest in CSC. And as is my practice, I've got 4 or 5 key messages here that I will cover with you and then develop in a little more detail, and then Paul will go through the numbers. And then as usual, we will open it up to any questions that you might have. So let me start here with the key messages. One, the first quarter results were generally consistent with our expectations for the start of our fiscal 2015 year. EPS from continuing operations was $1.03, and this did benefit from a lower tax rate. Our commercial business performed in line with our expectations. Revenue was up 1% year-over-year on a GAAP basis and down 1% in constant currency, and did include the benefit of a few extra days in the quarter. Our commercial bookings were solid with a 1.1 book-to-bill. The third message here is our NPS business continues to perform well in the current environment. Revenue was up sequentially. The year-over-year revenue decline moderated, and the operating margin was significantly higher, both sequentially and year-over-year. Bookings, however, continue to reflect the uncertain budget environment, and in many cases, delayed decision-making. The fourth key message that I will get into a little more detail in a minute is that we continue to position CSC for future growth by investing in new offerings and partnerships with leading technology companies, most recently our announcement this afternoon with IBM. And we are seeing some early positive signs from these investments, which we expect will help drive revenue growth and profit improvement as we progress through fiscal 2015. And finally, we are maintaining our targets for the fiscal year with EPS trending towards the high end of our range of $4.35 to $4.55. We continue to target commercial revenue to grow modestly and for NPS revenue to be down in the mid-single digits, which would translate into total revenue being flat to slightly up. We also continue to expect to generate free cash flow of around $700 million, and we will continue to return capital to shareholders in the form of dividends and share buybacks. So let me just go into one level deeper here on those key messages here. As I said, our first quarter EPS from continuing operations was $1.03, which benefited from a lower tax rate. Last year, we reported EPS from continuing operations of $0.93 before the change in our pension accounting policy, which Paul will cover in a little greater detail in a few moments. Our operating margin was 9.4%, with NPS operating margin of 14.8% and commercial operating margin of 8.1%. Now in our commercial business, Global Business Services operating margin was 9.9%, reflecting the ongoing reposition of our consulting business as well as other businesses that we're making investments in. Global Infrastructure Services, or GIS, the operating margin was 6.3%, and the GIS margins were impacted by planned investments in next-generation offerings, our strategic partnerships as well as a few contract restructurings in the quarter. And we continue to believe these actions will position CSC for improved growth and profitability over time. And we generated $70 million of free cash flow in the first quarter, which was driven by better working capital management. Now, as I said, our commercial business performed in line with expectations. Commercial revenue of $2.2 billion was up 1% year-over-year on a GAAP basis and down 1% in constant currency. GBS revenue of $1.1 billion was up 3% year-over-year on a GAAP basis and up 1% in constant currency. Our IS&S business, which is essentially our software business within GBS, was up 10% year-over-year on a GAAP basis and up 7% in constant currency with particular strength in banking and health care. Most notably, the U.K. National Health Service, NHS, is performing well, and we recently won a new contract with North Bristol NHS Trust, which was the first trust to select Lorenzo in an open procurement and the first one in the South England region. Our applications revenue was up 1% year-over-year on a GAAP basis and down 1% in constant currency. Consulting was down 10% year-over-year on a GAAP basis and down 12% in constant currency as we continue to reposition this business to a technology consulting model. We're hiring new consultants and building new practice areas, such as Workday and Salesforce.com, which unfortunately takes some time. Our repositioning effort has also, in all candor, been hampered by some execution issues, and we recently made an executive change in the leadership of that business unit. GIS revenue of $1.1 billion was down 1% year-over-year on a GAAP basis and down 3% in constant currency. This revenue performance reflects several factors that we've discussed before, including contract restructurings, timing around the operationalization of our strategic partnerships, price-downs, and contract completions. Now partially offsetting these trends is growth from our next-generation offerings in the quarter. Our commercial cloud revenue was up 55% year-over-year in constant currency. Our commercial cyber revenue grew 21% year-over-year in constant currency. Our commercial bookings of $2.4 billion were up 15% year-on-year for a book-to-bill of 1.1 versus 1.0 a year ago. GBS bookings of $1.2 billion and book-to-bill of 1.1 were unchanged year-over-year. The GIS bookings were also $1.2 billion, but they were up 39% year-over-year. And the book-to-bill was 1.1, an improvement from 0.8 last year. It's worth noting that 75% of the GIS bookings in the quarter were for new work. Our next-generation offerings again showed very healthy bookings. Our cloud book-to-bill was 2.2, our commercial cyber was 1.2, and big data was 1.7. Nearly 90% of our next-generation bookings in the quarter were for new work versus around 70% in the year-ago period. Overall, our commercial business continues to participate in the broader industry trend of smaller deal sizes. Deals under $50 million were up 13% year-over-year, and about three-quarters of these bookings were for new work. We also won 2 contracts in the quarter that were valued at more than $100 million each, and these 2 also represented new work for the company. We're also encouraged by the growth in qualified pipeline, especially in our next-generation offerings, such as cyber, cloud, and applications. Now turning to the NPS business. NPS revenue was $1.018 billion in the first quarter, down 3% year-over-year and up modestly on a sequential basis. The NPS operating margin of 14.8% reflects continued cost takeout and favorable contract performance. However, we expect that the NPS operating margin will moderate as we go through the remainder of the fiscal year. NPS bookings were $300 million, representing a book-to-bill of 0.3, down from 0.6 a year ago. These awards are notoriously lumpy and also reflect some continued uncertainty in the federal budget environment. However, our submitted proposals awaiting awards increased by $1 billion year-on-year to $3.5 billion, giving us some cautious optimism that we could see some modest improvement in demand later this year. Our NPS pipeline is up over 40% year-over-year and 30% sequentially at quarter end. This includes a pipeline of more than $1 billion of next-generation services. Excluding the large Department of Defense Healthcare Management System modernization opportunity, the NPS pipeline was still up over 20% year-over-year. The management team continues to take actions to prepare the NPS business in the event that the spending environment does not improve. Now turning to positioning CSC for future growth by investing in new offerings. We continue to position the company to take advantage of the shift in the marketplace. Clients are clearly seeking to modernize their applications and orchestrate workloads across multiple cloud environments, which are much more agile and cost-effective, and CSC is well positioned to benefit from this market shift. We are a leader in hybrid cloud solutions, and we've partnered with many of the leading cloud providers, including Amazon, Microsoft, and VMware. Today, we announced an expanded alliance with IBM to integrate IBM's SoftLayer with CSC's ServiceMesh Agility Platform. IBM plans to offer the Agility Platform to its clients, and CSC will offer Bluemix, IBM's open application environment. We're also continuing to operationalize our partnerships. We're working with HCL to build a world-class application modernization delivery network, and we've identified over 500 million in potential opportunities, which we are jointly pursuing. We partnered with AT&T to transition our network management and create the foundation for a hybrid cloud environment. Together, we built a pipeline of new business opportunities that now exceed $2 billion. As a matter of fact, today, we were awarded our first win of $150 million. CSC is also making significant investments to help reignite our revenue engine and bring to market our next-generation services offerings. For example, we continue to invest in upgrading our sales force, and we're increasing the amount of business that we are bidding on. So we were very cautious about this last year. We're beginning to increase the number of opportunities we're bidding on. In the quarter, our sales spending increased significantly year-over-year with more than $4 million for higher bid and proposal spending. In our cloud business, we're investing in the next version of our industry-leading private cloud offering, BizCloud, and we continue to integrate our ServiceMesh Agility Platform with our cloud partners, Amazon, Microsoft, VMware, and now IBM. During the quarter, a major commercial bank selected CSC to assist with the company's transition to a hybrid cloud infrastructure, which includes both BizCloud and ServiceMesh. I think this is a terrific example of the early stages of traction around that strategy. We're also investing in MyWorkStyle, a new virtual desktop offering. During the first quarter, CSC signed a $300 million contract with a large insurance company to deploy a highly secure virtual desktop solution for well over 100,000 of their employees globally. We're also investing in cyber, and we've expanded our portfolio of next-generation cybersecurity offerings. CSC was recently recognized as a leader in worldwide managed security services by IDC, and we're adding to our capabilities with the recent acquisition of a privately held cyber systems engineering and software development services company that will be primarily focused in our NPS business. Another positive sign is the growth in our commercial pipeline, which is up over 6%. Truthfully, what we now need to see is these investments beginning to pay off in the second half of the year, including converting our pipeline to bookings and to revenue. While we're still fairly early in this market shift to next-generation IT services, we're encouraged by some of the early signs that we're seeing with the results we are posting today. To wrap up here before I turn it over to Paul, I want to update our target for fiscal 2015. We are targeting modest commercial revenue growth and mid-single-digit declines in our federal business, which equates to total revenue being flat to slightly up. We expect our cost takeout to ramp up over the course of the year, benefiting from greater efficiencies in our G&A functions, improvements from our supply chain management, better contract management, and increased utilization of our low-cost delivery centers that we've talked about before, and productivity gains from our investments in automation. At the same time, we're continuing to reinvest in next-generation offerings, our HR and financial systems, and restructuring as well as customer-committed savings. We'll continue to target a net pretax benefit of approximately $100 million from our cost takeout and reinvestments, which is reflected in our EPS targets. Following our first quarter results, we're maintaining our EPS range of $4.35 to $4.55, although we are trending towards the upper end of that range. We're also maintaining our free cash flow target of around $700 million. We continue to return capital to our shareholders; during the quarter, CSC returned $177 million in cash to shareholders, consisting of $29 million in dividends and $148 million in share repurchases. We also raised our quarterly dividend during the quarter by 15% to $0.23 a share. With that, I will turn it over to Paul for a little more detail and comments.

Yes. Thank you, Mike, and good evening, everyone. Before discussing our first quarter, I'd like to point out 3 items that are reflected in the results. First, during the quarter, CSC adopted a new mark-to-market pension accounting policy, which recognizes actuarial gains and losses on the fair value of pension assets each year. Previously, these gains and losses were amortized over the life expectancy of plan participants. Other elements of our pension expense do not change and continue to flow through our income statement. The benefits of the new pension accounting policy include greater transparency in the operating results, increased comparability with our peers, and greater flexibility in managing our pension liabilities, such as facilitating lump sum settlements. The impact of this accounting change was a $21 million pretax benefit in the quarter, which we reinvested in the business as previously planned. The impact was a $23 million pretax benefit in the prior year. Our pension funding requirements, our cash flow, and pension benefits are not affected by this new policy change. Second, as part of our new financial system transformation, CSC changed its intercompany accounting. Intercompany transactions are now treated as cost transfers and not intercompany revenue. We've recast our financial statements for the year-ago period to reflect the new pension and intercompany policies. Lastly, our first quarter included an extra week when compared with the prior year. This occurs every 5 years, given the company's fiscal year convention. The revenue impact of the extra week consists of 2 components. There's a $39 million amount, which represents the amortization of fixed fee contracts, coming primarily from our GIS business. This amount will normalize in subsequent quarters and will have no impact on our fiscal year. There is a variable component for revenue, which is influenced by several factors such as business mix, timing of vacations, and the number of holidays in the period. This variable revenue component is very difficult to estimate and could range from a very low number to $80 million in the quarter. In any case, the amount will be immaterial to our full year results. Now let me turn to our first quarter results. Revenue for the quarter was $3.2 billion, relatively flat on a GAAP basis and down 1.9% in constant currency. Operating income in the quarter was $304 million. Operating margin was 9.4%, down about 80 basis points year-over-year. Earnings before interest and taxes were $248 million, and EBIT margin was 7.7% compared with 8.3% in the prior year. Income from continuing operations was $159 million in the quarter. EPS from continuing operations was $1.03 and included a benefit of $0.08 year-over-year from a lower tax rate. In the prior year, we reported EPS of $0.93 prior to the change in pension accounting policy. Booking in the quarter were $2.7 billion compared with $2.8 billion in the prior year. Now let's look at our segment results. Global Business Services accounted for 34% of total company revenue in the quarter. GBS revenue was $1.088 billion, up 3.2% on a GAAP basis and up 0.9% year-over-year in constant currency. Our industry software and solutions business increased by 10% on a GAAP basis and 7% in constant currency, led by banking and health care. Applications business revenue was up 1% on a GAAP basis and down 1% in constant currency. Our consulting business was down 10% on a GAAP basis and 12% in constant currency, primarily due to the repositioning of the business, as we've previously discussed. We expect the actions we're taking in our consulting business to yield improved results as the year progresses. The GBS operating income was $108 million in the quarter. Operating margin was 9.9%, reflecting incremental investments in sales and next-generation offerings. We also experienced higher costs on a couple of projects. GBS bookings were $1.2 billion, and our book-to-bill was 1.1 for the quarter, relatively unchanged from the prior year. If we turn to our Global Infrastructure Services, the segment represented 35% of total revenue in the quarter. Our GIS revenue was $1.1 billion in the quarter, down 1.4% on a GAAP basis and down 3% year-over-year in constant currency. GIS revenue was impacted by price-downs, the restructuring of a few contracts, and contract completions. Our commercial cloud and cyber business continued to show strong year-over-year growth with cloud revenue up 55% year-over-year and cyber up 21% year-over-year. GIS operating income was $71 million in the quarter. The operating margin for GIS was 6.3%, reflecting investments in next-generation offerings of cloud, cyber, MyWorkStyle, and Storage-as-a-Service. We're also investing to operationalize our strategic partnerships with key partners like AT&T, Amazon, Microsoft, and VMware. We're also incurring upfront costs related to the movement of workloads to lower-cost geographies. The benefits of our ongoing cost takeout activities and the sale of an intangible asset helped to partially offset these investments. Bookings were $1.2 billion in the quarter, up 39% year-over-year for a book-to-bill of 1.1. Our North American Public Sector business accounted for 31% of total revenue in the quarter. Revenue was about $1.02 billion, a decline of 3.3% year-over-year. The NPS operating income was $151 million in the quarter, with an operating margin of 14.8%, up from the year-ago period on better contract performance. We expect the NPS margins to moderate over the coming quarters as we pass along cost savings to customers who are on cost-plus contracts. NPS bookings were $300 million in the quarter for a book-to-bill of 0.3. Let's turn to other financial highlights. Our tax rate was 25.7% in the quarter, reflecting our global mix of income and a favorable tax outcome in a foreign jurisdiction. For the remaining quarters of the year, we're still targeting a 32% tax rate, but we are cautiously optimistic that our tax planning activities may allow us to achieve a lower effective tax rate. Free cash flow was $70 million for the quarter on better working capital management, and we ended the quarter with $2.4 billion in cash. CapEx, including capital leases, was $203 million, or 6.3% of revenue for the quarter versus $220 million or 6.8% of revenue in the prior year. In the quarter, we continued to return more capital to shareholders. We repurchased 2.4 million shares for approximately $148 million, at an average price of $62 per share. We also paid $29 million in dividends. In total, we returned $177 million of capital to our shareholders, or about 110% of our income from continuing operations. Turning to cost takeout and reinvestment activities in the quarter. We realized approximately $105 million of cost reductions this quarter compared to last year's results before pension adjustments. Our cost savings came from greater efficiencies in G&A functions, improved supply chain management, and continued real estate optimization. Our reinvestment totaled $100 million in the quarter. We continue to make investments in next-generation offerings in addition to investments to increase our sales capacity, operationalize our strategic partnerships, and implement new HR and financial systems. As you know, we're also investing in customer-committed savings and in restructuring in support of our workforce rebalancing initiatives. For the full year, we continue to target cost savings of $450 million to $500 million and investments of $350 million to $400 million. In summary, our Q1 results were in line with our expectations. For the full year, we continue to target modest commercial revenue growth and a mid-single-digit decline in NPS. Our total revenue target for CSC is flat to slightly up for the full year. We're targeting EPS from continuing operations to be in the range of $4.35 to $4.55, although we are trending to the high end of that range. Our free cash flow target for fiscal 2015 remains at $700 million. With that, I'll turn the call back over to the operator for our Q&A session.

I'm wondering if we could just look at the federal business just for a minute and talk a little bit about your optimism at the back half of the year. I know, Mike, you said the same thing 3 months ago, and I'm just wondering based on what you've seen over the last 3 months whether you're equally as optimistic that we could see a return to better contract activity and awards in the back half of the year or based on what you've seen in the last 3 months you're perhaps a little more pessimistic than you were 3 months ago.

Yes, David, I would say that it's pretty much the same. We are seeing an increase in business that we have bid on and are waiting for awards. As we approach the end of the government's fiscal year, there are discussions around potential late fiscal year awards, possibly by the end of September or early October. The evidence of this is the rise in the number of awards pending final decisions. I don't anticipate any major changes in the overall environment moving forward. We are pursuing some large contracts like the Department of Defense Healthcare Modernization, which likely won't be resolved this fiscal year. There are some additions to contract negotiations that give us some cautious optimism for slight improvements in the spending environment. However, if I had to summarize it right now, I would say it remains largely the same. We are making significant efforts to submit unsolicited bids, and we believe this is helping us capture a larger share of available opportunities. This was evident this quarter as we saw a year-on-year decline moderate to around 3% and a slight sequential improvement. We will need to monitor what occurs this quarter and in the upcoming quarters.

Got it. And then just going back to the consulting business, can you help us better understand how much of a drag that is in terms of the overall growth rate of the GBS unit?

It is a significant drawback, to be honest. As I've mentioned previously, we've been repositioning this business, but some of the issues were simply due to poor execution on our part. I have made a change in management and leadership there. I believe the business is beginning to show some signs of improvement, but the 10% decline in consulting is negatively affecting our overall revenue growth and has a considerable impact on GBS.

I guess a couple of housekeeping things to get out of the way first. One is give me the organic growth rate. And also on the pension change, I missed whether there was a cash flow impact.

Yes, I'll let Paul respond to that.

Yes. On the organic growth rate, the rate that we give you is basically reflective of the actual growth. We mentioned the benefit of the extra few days in the quarter, but the only thing we can point to is in the GIS business, which was about $39 million in fixed revenue fees. The rest of it is very speculative in terms of understanding exactly what is the contribution for those extra days. As far as the impact of cash flow for the pension, there was none.

No, on organic, I meant any impact from past acquisitions.

Minimal. There is none in the quarter. In fact, there was more stated on a more comparable basis.

Okay, got it. And one question I just have is you guys have signed some really interesting alliances here, the one with IBM today, you have one with HCL and so on and so forth. I continue to be curious as to how the go-to-market works with these kinds of demand.

It's a very good question. So I'm going to give you an example of a deal we're involved in right now. I can't obviously put the name of the client out there. But we are bidding a very large deal that involves infrastructure transition to cloud and application modernization, both key enterprise line of business applications, as well as other applications. We are bidding with SAP. We're bidding with Amazon, and we are bidding with HCL. The way we've done this, the go-to-market is we've actually come together as one team. So we're actually sitting in a room. In the country where we're doing this work, we've sat together as a bidding proposal team for the last 2 months, and we are working as one team. When I approved the pricing, it's myself and in some cases the other CEOs who are approving the pricing. We’ve architected the solution together. Our solution architects and engineers, their solution architects and engineers, all working as one team. In fact, when we do the orals, which is part of a big deal like this where you have to present it, we're presenting it as one team. The customer is actually beginning to see us work as one team. I don’t want to make this sound like it's a simple thing to do because you have to learn to work with sometimes competitors in other situations. But we're learning how to do that. The client is seeing the benefits of that, and the overwhelming benefit, I just talked to one of the top executives last week, is that they are getting the best solution the industry has to offer as opposed to having to sub-optimize around one vendor. We’re seeing this play out now in multiple engagements. We’re getting some really good traction. I mentioned today we had a big win with AT&T in one of our network deals. Again, that was something we priced together and teamed together. Operationally, that's how it works. It's interesting when the CEOs get together and agree to do this stuff, but what's really important is how does it play out at the point of contact with the client. And that's what I mean by operationalizing these partnerships. As you get some successes, you share those successes on a global basis, and that's what begins to get the momentum behind the partnerships.

This is Ashish Sabadra calling on behalf of Bryan Keane. A quick question on NPS. NPS saw some pretty good sequential improvement from last quarter. But despite that, you've kept your guidance of mid-single-digit decline. I was wondering, is that because of the soft bookings or was there any some one-time benefit you received in the quarter? How should we think about the growth going forward for the rest of the year?

Yes, that's a good question. Every quarter, as you know, we have contract completions, and then we adjust some of those contracts. When we outperform our plans, we acknowledge it at that time. We did experience some of that in the first quarter. The bookings were quite low, at $300 million, which is a decline year-over-year. I don't particularly worry about one quarter's results due to the naturally uneven nature of bookings. Until I observe a bit more consistent strength and demand in that market, I’m hesitant to alter that outlook. Currently, I don't see it. We're making some progress on reducing costs, which provides us with a bit more confidence towards the higher end of our earnings per share. However, I still don’t see the revenue growth needed, and that's why we've arrived at our current position.

Okay, that makes sense. And then quickly on the GBS margins. I believe on the last call, you mentioned you could deliver more like 14% to 15% EBIT margins for the full year. Now you also highlighted some of the misexecution on the consulting side, and I don't know if that weighed on the margins for GBS. I was just wondering, does that change the expectations for margins for GBS for the full year? And just in terms of the consulting, when do you expect the turnaround?

Again, it's a very good question. No, I'm not changing the outlook for margins there. I will say that there would be some downward pressure given the performance in the first quarter. But I don’t, at this point in time, see a reason to adjust those margins down as we go through the year. The consulting business should begin to show some improvement this quarter. We thought we were going to see it in the first quarter, and when I talked about some misexecution, that’s what I'm referring to. We expect to clean up some of those execution issues. Our second quarter, which is summer in North America, is usually a tough quarter for consulting because of all the vacations and loss of billable time. Notwithstanding that, to be candid, I was surprised that the business declined 10%. We weren’t expecting a decline of 10%. It was a drag on the overall company's performance and certainly on GBS. We're expecting to see some improvement in the second quarter and then a strengthening as we get into the second half.

I had 2 questions I'll just ask you upfront. Mike, you had mentioned with regard to the utilization of your offshore facilities, and I was wondering if you could give us a progress report in that regard, and even if you have a metric, that might be helpful. And then with regard to the free cash flow, Paul, you mentioned that you had a reduction in CapEx as a percentage. I think it was at the low 6s CapEx percentage of revenue. Where should we anticipate that can travel over the course of the year?

In the first quarter, we concluded what we call Delivery Excellence 2 in 6 accounts. When I say Delivery Excellence, we are going account by account where we work with the client on moving more work and workload to our lower-cost centers around the world. In those 6 accounts, we saw several very important metrics. One, we saw a reduction in overall tickets. We saw an improvement in time to respond. We saw a significant improvement in our ability to move workload to low-cost centers. For example, we've reduced in those accounts about 500 jobs that we could move to the low-cost centers. I reviewed those results about 2 or 3 weeks ago, and we've made the decision now to implement that program in another 40 to 50 accounts. We did a quick survey, what we call a pulse survey with the customers, and we saw customer satisfaction improve. Our own internal employee satisfaction increased dramatically. It's going to take a little longer to do this. We are going account by account to avoid impacting our service delivery capability or customer satisfaction. It gives us a little color on what we are doing there and we're encouraged by that progress.

In the free cash flow, it reflects right now a CapEx in the $850 million for the year.

Paul, can you give us some color on what sort of dilution you had during the quarter from ServiceMesh?

In total, I would say the investment that we are doing in cloud in general was about a $20 million drag on our profitability.

Okay. So that included the impact of, I mean, of the D&A from ServiceMesh, right?

Yes, correct.

Okay. And then you spoke a bit about the NHS. Is that a profitable contract right now? I mean, if I remember, it was operating at breakeven levels.

Yes, NHS is remarkable, and I give enormous credit to the team that runs it. This initiative has cost us billions, but we are now generating profits in NHS. We have successfully implemented our services in 4 or 5 trusts and are making money from those trusts. The key point of our discussion today is that when we renegotiated the contract, we relinquished our exclusivity for the region previously awarded to us by NHS. In return, we gained the right to compete across the U.K. The Bristol NHS trust, which is a substantial trust, was acquired from a competitor. This marks our first significant win outside of the region where we had prior advantages. We succeeded without any subsidies from NHS, relying solely on our capabilities. We expect to continue making profits because we have delivered the Lorenzo product suites, which are operational, and there is minimal additional development needed for the new trusts we are bidding on and winning.

Okay. So when you say make money, are we talking about optimal profitability? Can we get some color in terms of what sort of profitability we can get from here?

Yes, we've gone from a loss to a high-single digit to low double-digit margin.

Okay, great. And then can you give us a...

This health care business, now on a global basis, is growing. This was a big drag on our performance a couple of years ago, and this business is beginning to grow again. We're beginning to bid now on other opportunities around the world. As we announced, we're partnering with Allscripts.

I want to ask about the DHMSM contract. Can you give us some time line in terms of potential awards and when can we expect that?

No, I really can't. I mean, it's an open procurement here. It's going to go through its normal cycle. I've got no idea, but I don’t think it'll be this year.

And is that an IDIQ contract?

No, I don't think so. There is an incumbent now, and I'm not sure under what contract vehicle it's currently contracted under. We could get that information, but I just don't know off the top of my head.

And then last question, you spoke a bit about shifting some work, very preliminary phase of shifting some work to low-cost locations. You mentioned 6 accounts. Is that a substantial part of the strategy down the road? Can you give us more details on where this is going to go next year or in the next few years?

Yes, it's a very substantial part of our strategy. It's what we expect to be the primary driver for improved margins in our GIS business. We're also doing the same thing with NPS. We announced 2 new centers in the U.S., one in Louisiana and one in Pittsburgh. Those centers are for both commercial and NPS work. We’re consolidating some of our centers, for example, in the Washington area and moving workload from here to those lower-cost centers. They serve both commercial and NPS business. We've got other centers in India and other places around the world. It is a major, major part of our strategy to continue to drive margin expansion, particularly in the GIS business. So, to put this in context, the industry had made this move years ago, I mean, 10 years ago. CSC did not make that move, and as a result, we have a lower percentage of our workload done in these offshore centers. I think when we started out, we were in the mid-20s, and now, George, correct me, I think we're in the mid- to high 30s. But there’s still a long way to go. This should be 60% to 70% over the long haul. It’s a major part of our strategy to continue to drive margin expansion across the board in our infrastructure and application business. We are seeing reductions in our delivery costs, especially in those 6 contracts. To quantify that estimate, I would say it was probably a couple of hundred basis points.

If I could just follow up to that last line of questioning on migration of workload to lower-cost geographies. What is the typical pricing power in those scenarios in terms of when you have a customer where you're moving their workload to lower-cost geographies?

Typically, what we've done here is we've restructured a lot of contracts. In restructuring, we often gave workload back to the customer, resulting in less revenue but higher profitability. This is how we improved our margins in GIS over the last couple of years. We want to absorb price-downs without margin degradation by moving that workload to lower-cost centers. To put this in context, the industry had made this move years ago, I mean, 10 years ago. CSC did not make that move, and we are expected to clear a path for both margin improvement and better service delivery as we move forward. In many cases, this isn’t just about costs; it's also about better delivery service, better SLA performance, and better support to our clients. When you provide better service delivery, you have an opportunity to cross-sell into those accounts, which is another area we are focused on. This is a major part of our improvement plans going forward. We’re down to a handful now regarding contract negotiations. Most of that is done. We have a handful left to do. That does put downward pressure on revenue as we renegotiate these contracts. We’re typically renegotiating at a lower revenue rate, but with greater profitability.