Leidos [LDOS] on Thursday reported a drop in net income in its third quarter due to higher taxes while sales jumped up due to an acquisition a year ago.

Net income fell 10 percent to $82 million, 53 cents earning per share (EPS), from $91 million (80 cents EPS) a year ago, as Leidos was hit with $37 million in tax expense versus a $17 million benefit last year.

Excluding various amortization, acquisition and integration, and restructuring costs from the two periods, adjusted earnings would have been 95 cents EPS in the recent quarter, 13 cents higher than consensus estimates. Adjusted margin in the quarter was 10.9 percent.

Leidos Chairman and CEO Roger Krone. Photo: Leidos
Leidos Chairman and CEO Roger Krone. Photo: Leidos

Sales were up 34 percent to $2.5 billion from $1.9 billion due to the $4.6 billion acquisition of the former Information Systems & Global Solutions (IS&GS) segment from Lockheed Martin [LMT] in the third quarter a year ago. The IS&GS business, which has been divvied up among Leidos’ three operating segments, contributed $1.3 billion to sales in the quarter versus $620 million a year ago when it was only owned by the company for a portion of the reporting period.

Leidos didn’t break out organic growth for the quarter but the IS&GS business grew as a whole while the company’s legacy revenues were down.

The company’s cash generation has been better than expected, allowing it to pay down its debt earlier than expected, Leidos officials said on their earnings call with investment analysts. With the debt leverage at the targeted ratio, Leidos is free to widen its aperture for cash deployment, Roger Krone, the company’s chairman and CEO, said.

Investing in internal growth remains a priority because it offers the highest return, Krone said. Internal investment includes spending on research and development, bid and proposal activities, and capital expenditures, and area where Leidos is spending $15 million more than planned this year for a sensitive government defense program to drive future sales and profit growth.

Additional areas for capital deployment include “meaningful share repurchase” and mergers and acquisitions, Krone said.

“We are pleased to once again have the full breadth of options more readily available to us as we look to deploy our excess capital in the best long-term interest of our shareholders,” Krone said.

Based on its performance so far this year, Leidos increased its expectations for margins, earnings, and cash flow. Adjusted margins are now projected to be between 10.2 percent and 10.4 percent versus the prior outlook of 9.2 percent to 10.2 percent. Adjusted earnings are 15 cents EPS higher to a range of $3.60 to $3.75.

Cash flow is expected to be at least $490 million versus the previous guidance of at least $475 million.

Orders in the quarter were $3.1 billion, representing a book to bill ratio of 1.2 times sales. James Reagan, Leidos’ chief financial officer, pointed out during the call that a number of wins in its Defense Solutions segment are in new indefinite delivery, indefinite quantity (ID/IQ) contracts, which can’t be allocated to bookings. He also said a $1 billion defense single award ID/IQ contract Leidos won, along with the first task order, has been protested and isn’t in the order tally for the quarter.

Leidos also won a contract from the Department of Homeland Security to deploy a new multimodal biometric enterprise database during the quarter. That award is being protested by Northrop Grumman [NOC]. Leidos is protesting a potential $578 million logistics award made by the Transportation Security Administration to Peraton, the former federal information technology services arm of Harris Corp. [HRS]. Leidos was the incumbent for the logistics work for the agency’s security used at airports nationwide.

The various protests related to Leidos impact billions of dollars in potential business, the officials said.

Backlog at the end of the third quarter stood at $17.6 billion, $5.6 billion of which was funded. At the end of 2016, backlog was $17.7 billion, of which $6 billion was funded.