Leidos - Earnings Call - Q2 2020

Transcript

Operator (participant)

Greetings. Welcome to the Leidos Q2 2020 earnings call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press * zero on your telephone keypad. Please note this conference is being recorded. At this time, I'll now turn the conference over to Peter Berl with investor relations. Please go ahead.

Peter Berl (Head of Investor Relations)

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our Q2 2020 earnings conference call. Joining me today are Roger Krone, our Chairman and CEO; Jim Reagan, our Chief Financial Officer; and other members of the Leidos management team. Today, we will discuss our results for the quarter ending July 3, 2020. Roger will lead off the call with notable highlights from the quarter, as well as comments on the market environment and our company strategy. Jim will follow with a discussion of our financial performance and our guidance expectations. 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 a supplementary financial information file, 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.

Roger Krone (Chairman and CEO)

Thank you, Peter, and thank you all for joining us this morning for our Q2 2020 earnings conference call. As we continue to navigate through these difficult times as a country and as a global community, I hope each of you are well and your families safe. Leidos' Q2 results demonstrate the resiliency of our business model, the value of our market diversity, and the strength of our team as we delivered on commitments through the most challenging quarter I have seen in my career. We exited the quarter with a strong business capture win rate, record-setting backlog, resilient cash position, and improved capital structure. These factors galvanize our optimism for the future despite the extended effects of the current pandemic. In the quarter, the business delivered revenue of $2.91 billion, reflecting 6.8% growth from the prior year.

Adjusting for acquisition and divestiture activity and effectively taking into account a full quarter's worth of COVID-19 impacts in specific areas within the business, organic revenue contracted by 3% over the same period. We recorded our non-GAAP diluted earnings per share of $1.55, up 34% from the prior year. In addition, we generated $422 million of cash from operations, ending the quarter with a solid cash balance of $588 million. Net bookings of $4.6 billion yielded a book-to-bill of 1.6 for the quarter, as well as a 1.6 on a trailing 12-month basis. These impressive business capture measurements do not yet reflect material contributions from several notable single-award IDIQs that were competitively won over the past several months. Upon receipt, those task orders will be captured in our bookings metrics in subsequent quarters. Adjusted EBITDA margin of 11.8% was greater than the prior year.

The primary factor was the net gain resulting from the Vernetix legal settlement for patent infringement, which was largely offset by a full quarter of the anticipated COVID-19 impacts we discussed during last quarter's earnings call. The impact of COVID-19 in the Q2 was approximately $222 million in revenue and $78 million in non-GAAP operating income. While some of the Q2 impacts will be recovered in the second half of 2020, we expect more of the recovery to push into 2021 as the pace of reopenings began both later and slower in the Q2 than previously estimated. Additionally, the security clearance processing timeline for new employees continues to lengthen, and some programs, such as Navy Next Generation, remain affected by ongoing protest activity.

In the meantime, due to the critical nature of our work, all of our Leidos facilities have remained open, and each has implemented safe workforce plans to protect the health of our returning colleagues. Per our guidelines, occupancy remains below 25% at this time, while more than half of our employee base continues to productively telework. Other than a small percentage that remain home in a ready state capacity, the remainder of our workforce reports to customer sites or other performance locations. From a subcontractor and supplier perspective, our business partner network remains resilient and in good health. We engage and monitor this important ecosystem daily. Lead times have improved during the course of the quarter, and our teammates continue to perform across all of our programs.

Equally important during the Q2, recruiting and talent acquisition remained strong, as evidenced by a nearly 8% growth in new hires compared to Q1. This metric excludes additions from M&A. Our ability to attract top talent in this manner is important as we staff up to successfully execute the new programs in our growing backlog, which now stands at a record $30.7 billion. This core competency will also prove critical as we prepare the business for continued growth, given the ongoing high pace of business capture activities across the diverse markets we serve. When we compare mid-March through June of 2019 versus the same period in 2020, we found that we submitted more proposals during the pandemic with an aggregate approximate value of $8 billion. Now turning to several notable awards. Leidos was awarded the Traveler Processing and Vetting Software contract by the U.S. Customs and Border Protection.

Under this new blanket purchase agreement, we will provide a full range of software development lifecycle services to support CBP's mission to safeguard America's borders and enhance the nation's global economic competitiveness. This single award BPA has a one-year base period of performance followed by four one-year option periods and a total estimated value of $960 million. The company was also awarded the Enterprise Standard Architecture 5, also referred to as ESA 5, task order to provide managed IT services for the Department of Justice Bureau of Alcohol, Tobacco, Firearms, and Explosives. The single award hybrid task order has one 10-month and two one-year base periods of performance followed by six one-year option periods. It includes a ceiling value not to exceed $850 million if all options are exercised.

Finally, our Dynetics subsidiary was awarded a sole source contract for the production and sustainment of foreign radar simulators known as the Laboratory Intelligence Validated Emulator, or LIVE, family of products. The contract has a total estimated value of $356 million for production and sustainment for the next 10 years. On the M&A front, we remain focused on the successful integration of both Dynetics and the former L3Harris security detection and automation businesses. Both are progressing on schedule. Since the Dynetics deal closed in late January, our integration has focused on combining our legacy Leidos Innovation Center—we call it the LINC—with our new Huntsville-based business. The LINC has a great track record of executing early-stage R&D for DARPA and the Air Force Research Lab, and through the combination with Dynetics, we see opportunities for rapid prototyping and producing a higher conversion rate of research projects to programs of record.

Other early collaborations led to important wins, such as NASA's Human Lander Systems contract under the agency's Artemis program. If downselected, the follow-on contract to place the first woman on the lunar surface and return man could exceed $4 billion. With security detection and automation, key business systems integration decisions have been made that further our confidence that the annual cost synergies of at least $20 million can be captured by 2022. Additionally, we are pleased with the expansion of our checkpoint solutions that will promote the safety and health of the traveling public and those entrusted to provide security services. To that end, in the quarter, we received an award at Edinburgh Airport in Scotland to upgrade the airport's security tray return systems with antimicrobial tray technology.

Also, the business was recently shortlisted for a five-year opportunity at Munich Airport for the manufacturing, installation, and service of explosive detection systems for cabin baggage. This work would represent an important step in our strategy to grow in the airport security solutions market. Turning now to the macro environment. Despite a likely continuing resolution in the fall, we expect minimal overall impacts to our business sector as the fiscal year 2021 budget levels are already set under the bipartisan budget agreement. Additionally, DOD has almost $125 billion in unobligated balances as of fiscal year 2019. Therefore, if budget authorities are flat, these balances can allow higher rates of outlay to address our customers' ongoing critical mission requirements. Looking through the Leidos lens, we are encouraged by our continued alignment with DOD's top 10 technology priorities.

The ongoing execution of our long-term business strategy further mitigates potential future headwinds for our business, as does our portfolio diversity, as approximately half of our business is aligned with the federal, civil, and health customers. With regard to our health business, I'd like to reiterate that yesterday we announced the appointment of Liz Porter as the new Health Group President. Liz has held that position in an acting capacity since early March. Prior to this role, she served as the operation manager for the Civil Group's federal energy and environmental business. Liz's demonstrated leadership experience in program management, engineering, and business development will continue to position Leidos for growth in the expanding health markets. Before I hand the call over to Jim, I want to acknowledge the pain over the continued injustice and violence suffered by the African American community.

Over the past few months, we have seen this pain and more tragedy. We all saw the killing of George Floyd in May and the tragedy in June as Rayshard Brooks in Atlanta was unnecessarily killed. I said this to our employees, on our website, and our social media platforms, and I want to say this again to you. Racism and social injustice have no place in our society or at Leidos, nor does any form of discrimination. Equality and justice must be a universal experience, and we must take action. At Leidos, we are working to find new ways to engage on these critical topics in order for us to move forward together in unity. To start, we are partnering with the Equal Justice Initiative, who fights against racial injustice and poverty and promotes equal treatment in our criminal justice system for the most vulnerable.

We have made a large donation in support of their important work, and I am moved by their focus on progress, education, and equal justice under law. Also, we are implementing inclusion training across our company and working to launch a Leidos Diversity and Inclusion Council, and we are hosting listening sessions with management for our employees across the enterprise. As CEO, I strongly embrace this responsibility, and I want to share that with you today. I will now turn the call over to Jim Reagan, our Chief Financial Officer, for more details on our Q2 results and guidance.

Jim Reagan (CFO)

Thanks, Roger, and thanks to everyone for joining us on the call today. As expected, Q2 has been a challenging quarter. However, our quarterly results reflect our team's agility to respond to the fluid environment. Let me start by sharing our quarterly results, an update on our recent financing activity, followed by an update to remaining year guidance, including COVID-19 impacts and assumptions. Q2 revenues grew 6.8% over the prior year period and contracted 3% organically. The increase in top-line revenue was driven by the recent acquisition of Dynetics and the L3Harris security detection and automation businesses. These increases were offset by approximately $132 million of COVID-19-related impacts. In addition, expected growth on existing programs was reduced by $91 million due to COVID-19. Without these pandemic-driven headwinds, our Q2 organic growth would have been about 5% over the prior year period. Adjusted EBITDA margins of 11.8% increased 180 basis points from the prior year quarter, driven by the following items. The first was the $81 million net gain related to the Vernetix legal matter.

The second was volume reductions on existing and new programs directly attributable to the COVID-19 pandemic of approximately $78 million. After adjusting for these discrete items and the related revenue impact of $222 million, adjusted EBITDA margins would have been 10.9%, reflecting strong program performance and reduced indirect costs for our business. Non-GAAP diluted EPS for the quarter increased $0.39 over the prior year to $1.55, driven by increased volume, strong program performance, and lower share count. The net gain from the Vernetix legal matter and COVID-19 impacts largely offset one another. Operating cash flows of $422 million reflect the one-time Vernetix litigation payment of $85 million, the incremental accounts receivable monetization of $74 million, and lower tax payments. As mentioned during our last earnings call, we remain committed to our long-term balanced capital deployment strategy.

In the quarter, we completed two actions toward our path to an adjusted net leverage target of 3.0x. At the end of the quarter, the metrics stood at 3.4. First, we refinanced $1.75 billion of loans associated with the acquisition of Dynetics and the L3Harris security detection and automation businesses. The deal marked our strong return to the investment-grade bond market, as evidenced by an oversubscription of approximately 12x, which facilitated lower rates compared to the initial price indications and simplified our debt covenant structure. The transaction extended our debt maturities, resulting in three tranches of senior unsecured notes, including a three-year, a five-year, and a ten-year, with a blended coupon rate of 3.75%. Second, we used the Vernetix proceeds of $81 million, coupled with strong cash generation from operations during the quarter, to pay down approximately $226 million of our debt.

We had another solid quarter in business development, resulting in bookings of over $4.6 billion, bringing our book-to-bill for the quarter to 1.6x and an overall backlog position of $30.7 billion. Large new business wins in the defense solutions segment and the Human Lander Systems program contributed to the record backlog number. Let me now take a moment to recognize the outstanding work by our business development and capture teams in submitting a world-class winning proposal for the $7.7 billion Navy Next Generation competitive procurement. As you are aware, the award was protested, and in June, the U.S. Government Accountability Office decisively denied two separate protests, including one from the incumbent. These decisions reaffirmed the outstanding rating assigned to Leidos by the customer across the most critical technical and management evaluation factors and also recognized our substantially lower price. We remain confident that we will prevail in the U.S.

Court of Federal Claims, and we look forward to ramping up the important work for our customer later this year. Until then, the award will be excluded from our reported backlog. I'll speak more to the ongoing protest later when we discuss our updated FY2020 guidance. Before turning to our segment results, I'd like to provide an update on our hiring, given its importance to the growth of the company. I'm pleased to report that we welcomed approximately 1,000 employees from the security detection and automation businesses that we just acquired, and we also onboarded nearly 2,000 additional new hires in the quarter. Q2 average weekly hiring has exceeded pre-pandemic levels, demonstrating our ability to attract top talent during a tight labor market.

The year-to-date annualized voluntary attrition rate has declined by approximately 230 basis points compared to the prior year, and we continue to invest in our people to drive retention and attract new employees. Now for an overview of our segment results. Defense solutions revenue grew 12.6% on a year-over-year basis. The primary driver for the growth was the acquisition of Dynetics. From an organic perspective, the segment contracted 0.6% due to $18 million of contract volume reductions directly related to COVID-19. In addition, expected on-contract growth was reduced by about $19 million due to COVID-19. Non-GAAP operating margins of 8.1% declined 20 basis points from the prior year quarter, primarily attributable to COVID-19 impacts, which were partially offset by program wins.

Defense solutions booked over $3.5 billion of net awards, including two large new business wins with our intelligence customers, resulting in a book-to-bill of 2.0x in the quarter and 1.5x on a trailing 12-month basis. In our civil segment, revenue grew 13.6% from the prior year quarter. This growth was primarily driven by the $80 million contribution from the acquisition of the L3Harris security detection and automation businesses and increased contribution from new programs, partially offset by $18 million of reduced volumes on programs impacted by COVID-19. Furthermore, the pandemic caused a reduction of $34 million in expected growth on existing contracts and delays to the ramp-up of new programs. On an organic basis, the segment grew 1.6% from the prior year. Non-GAAP operating margins in the civil segment were strong at 12.9%, reflecting a 180 basis point increase over the prior year period.

This increase was driven by the acquisition of the SD&A business, program write-ups, and performance on new programs. Civil generated nearly $1 billion in net bookings in the quarter, reflecting the successful resolution of a protest on a new business award and the ESA 5 re-compete award mentioned earlier. The result was a book-to-bill of 1.3x for the quarter and 2.1x on a trailing 12-month basis. Finally, turning to our health segment. Revenues were uncharacteristically low, declining 20.4% from the prior year period due to $96 million of COVID-19 impacts and the sale of the health staff augmentation business in the Q3 of 2019. In addition, expected program growth, reflected in our previous guidance, was lower by $38 million due to COVID-19. These negative impacts were partially offset by contributions from new programs and the acquisition of IMX in the Q3 of 2019.

After adjusting for the COVID-19 impacts and the acquisition and divestiture activity, revenues would have increased 11% year-over-year. Non-GAAP operating margins for the health segment were 5.3% for the quarter. This lower-than-normal margin was the result of COVID-19-driven volume reductions on certain managed service contracts with fixed-cost infrastructures. Our health segment saw approximately $150 million of bookings in the quarter, driving a book-to-bill of 0.4x, with a trailing 12-month book-to-bill of 0.9x. Moving now to the remainder of the year. We're updating our guidance across all metrics to account for our Q2 results, additional COVID-19 impacts, and increased visibility for the second half of the year. We're adjusting our revenue guidance to a range of $12.2 billion-$12.6 billion, which is a reduction of $300 million, or 2.4%, from the prior range midpoint and represents a 12% increase over 2019 results.

This $300 million reduction includes additional COVID-19 impacts, which reflect the slower-than-anticipated customer reopenings, the delayed ramp-up of the Navy Next Generation contract, and various other program delays and volume changes. As the NGEN protest has moved from the GAO, where it was fully decided, to the Court of Federal Claims, we remain confident that this protest will be resolved in our favor. However, this does delay the full transition until late in the Q4, continuing into 2021. Note that in our previous guidance, we expected our COVID-impacted programs to begin to ramp up back to normalized run rates during the Q2. However, with slower customer openings, we now expect programs to return to their normalized run rates in the Q4 and then continue unimpacted into 2021.

We anticipate that the majority of the 2020 impacts will be recovered in 2021, reinforcing our confidence in the ability to grow more than 10% organically next year with margins at or above our 10% adjusted EBITDA margin target. In terms of margins, we expect adjusted EBITDA margins of 10.0-10.2% for the year. This 20 basis point increase at the midpoint from the prior range reflects the net gain from the Vernetix litigation and the reduced indirect rates, partially offset by the impact of lower margins within the year in our health segment. As a result of these new ranges for revenue and margins, we are updating our non-GAAP diluted EPS guidance range to $5.25-$5.55.

This increase of $0.25 at the midpoint from the prior guide reflects the net gain received from the Vernetix litigation, a slightly lower tax rate, and reduced interest expense for the year, offset by the COVID-19 impacts discussed earlier. Finally, we expect cash from operations to be at least $1.2 billion for the year, up from the prior guide of $1.0 billion, reflecting the proceeds from the Vernetix litigation and an anticipated $100 million increase in the net receipts from the accounts receivable monetization facility. Now, two additional items to note to help you with modeling. We expect lower net interest expense for the full year of $176 million, a decrease that reflects lower interest rates to our debt restructuring, and a slightly lower non-GAAP tax rate in the range of 21-22%. With all that, I'll turn it over to Rob so we can take some questions.

Operator (participant)

Thank you. We'll now be conducting a question-and-answer session. If you'd like to ask a question today, please press * 1 from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press * 2 if you'd like to remove your question from the queue. For participants that are using speaker equipment, we ask that you please pick up your handset before pressing the Star keys. Thank you. Our first question comes from the line of Robert Spingarn with Credit Suisse.

Roger Krone (Chairman and CEO)

Hi. Good morning.

Robert Spingarn (Analyst)

Hey. Good morning.

Roger Krone (Chairman and CEO)

Hi, Rob.

Robert Spingarn (Analyst)

Just on the back of what Jim just went through, and Roger, you talked about this too. I just want to be clear on the pressure, particularly in the health segment. Are you saying that's mostly timing-driven and that you're going to recover a lot of that next year?

Roger Krone (Chairman and CEO)

Yeah. It has to do with some of the medical exam work that we do. Think about it as fixed infrastructure, and because of COVID, a lot of facilities are shut down, and we have moved some of that to telehealth and some of that through review of existing medical records. The vast majority of the work that we do requires a medical exam. Those are medical exams that have to be done, whether it be workman's comp or a disability benefit. Those have rolled, if you will, into backlog. You will think of it as a simple inventory. Those need to get done, and they're not getting done. The individuals who need that benefit need a medical exam.

If they did not get it in Q2, then they are in the backlog now for Q3 and Q4, but it is just going to take time to work through the backlog. It is literally a timing. What we have seen in the past, Rob, when we have seen the backlog, we will surge, right, and conduct more exams than normal to catch up. This is not a permanent timing difference. It literally is just a delay, and then we will surge. Sometime, probably late in 2021, we will come back to normal.

Robert Spingarn (Analyst)

I see. It is not like they can get the exam elsewhere or that it is somehow lost share or anything like that. It is they come back to you.

Roger Krone (Chairman and CEO)

No. Yeah. All of the offers of these exams, whether they be workman's comp or disability, are in the same boat. We've all been shut down, and the backlog has, unfortunately, grown. We are now 85% open, something like that, as of earlier this week. It is just going to take time now to work through the backlog, and we're committed to go do that.

Robert Spingarn (Analyst)

Okay. The other thing I wanted to talk about, I think it's very interesting, but your role on Skyborg as the system design agent. I wanted to see if you could talk about the scope, perhaps, of that contract and if the work scope there is kind of a one-and-done or if you have any kind of recurring revenue stream from Skyborg long-term.

Roger Krone (Chairman and CEO)

We're essentially the systems engineering contractor for the customer. As you know, I think you may have written, there are a handful of other companies that are working on the concept and the vehicle. Our job on that program is to assist the customer in doing technical assessments and systems engineering at the concept level. It's a nice program for us. We're obviously very, very pleased with it. It is not our largest program and probably won't grow to be because of our systems engineering role. We stand more along with the customer and the user than we do with the companies who may be designing and building the vehicle.

Robert Spingarn (Analyst)

That makes you somewhat agnostic on how this plays out. Your role is there.

Roger Krone (Chairman and CEO)

Absolutely. Yeah. Absolutely.

Robert Spingarn (Analyst)

Does this help you with autonomy efforts down the line?

Roger Krone (Chairman and CEO)

I think it helps us in many areas with autonomy, with systems engineering. It advances, if you will, our past performance and our qualifications in the area. And when we assessed it, we viewed we didn't really have an airborne offering, and a better position for us was to be in the systems engineering role with the customer. So it's a great qualification for us.

Robert Spingarn (Analyst)

Great. Thank you very much.

Roger Krone (Chairman and CEO)

You're welcome. Good morning.

Operator (participant)

The next question is from the line of Sheila Kahyaoglu with Jefferies.

Sheila Kahyaoglu (Analyst)

Hi. Good morning, Roger, Jim, Peter.

Robert Spingarn (Analyst)

Hey. Good morning.

Sheila Kahyaoglu (Analyst)

Roger, I guess related to Rob's question to a degree, there's an element of Leidos with a thesis changing as the organic leader in the growth space given your recent wins like NGEN. However, obviously, during COVID, I thought you gave a great explanation in May about the impacts of COVID, whether it was Dim Sum and Antarctica. Clearly, the scope of the COVID impact extended beyond those programs. I guess, why do you think those businesses were impacted? You touched upon it a little bit just now, but how do you think that normalizes, and how do we think about, I guess my follow-on is, how do we think about 2021? You say in the slides you normalize in Q4, whether it's revenue growth and margin mix.

Roger Krone (Chairman and CEO)

Yeah. I'll get started, and I'll let Jim finish. By the way, the defense health program, the electronic records program for DHA is only impacted to a very, very slight. In fact, we would reiterate that the completion schedule is still on track in the 2023 timeframe. Most of our digital transformation work in the healthcare business is pretty close to on schedule. We haven't seen huge numbers there. Really, the impact this quarter has been in the exam business that we have, and it really caused us to take a couple of months where we just couldn't get the exams done. Maybe I'll let Jim expand on that a little bit, sort of our fixed cost, variable cost view of our examination business.

Jim Reagan (CFO)

Yeah. Sheila, I think Roger said it well, but to just emphasize the point on what's changed from when we talked about the expected impacts a quarter ago, the real change has been that the impact of the pandemic in a number of geographies has been more prolonged and perhaps more severe than we had visibility to 90 days ago. That has caused some of our customer sites and some of our examination sites to be closed longer than expected, and they returned to work. Some of our customer sites, whether it's our intelligence customers within the defense solution segment or the places where we serve patients for these medical exam services, all of those have had a longer and more prolonged return to opening than we expected just three months ago.

Roger Krone (Chairman and CEO)

Sheila, your comment about 2021, I think, was right on. We expect to come back to a normative level in the Q4 and then, therefore, exceed that level in the exam business in 2021. Obviously optimistic about what 2021 will look like.

Sheila Kahyaoglu (Analyst)

Great. Thank you.

Roger Krone (Chairman and CEO)

Thank you.

Operator (participant)

The next question comes from the line of Kai von Rumer with TD Cowen.

Kai von Rumer (Analyst)

Yes. Could you please give us a little insight into recovery under the CARES Act? For example, the areas in which you expect recovery, is that medical exam? And do you have any hope, and is it in your bookings, that you would get recovery of fees?

Jim Reagan (CFO)

Yeah. Kai, I'll start, and if Roger has more to say, he'll pile on. The CARES Act impact is actually helping us keep a number of employees in the defense solution segment, primarily in the intelligence agency customer set, in a ready state. We are able to recover full cost but not fee for those people. It is no more than 5% of our employee base. The CARES Act does not cover the recovery of ready state employees or facilities for the contracts that we have in our health solutions business for two reasons. One, a certain amount of that revenue is from commercial customers. Think about insurance companies for whom we are doing disability exams and so forth, but also our government customers, because these are done on a fixed unit price basis where we do have some significant fixed infrastructure. Think about lease costs and the cost of staff to process these exams. Those costs are not normally covered by the provisions of the CARES Act. That is the primary impact that you're hearing us talk about in the health business.

James Reagan (CFO)

Thank you.

Operator (participant)

The next question is from the line of Seth Seifman with JPMorgan.

Seth Seifman (Analyst)

Oh, thanks very much. I was just curious with regard to the 300 of incremental impact. Should we think of that as being the vast majority of that in the health business? I guess on the defense side, we kind of thought of the main challenge for COVID-19 for federal service providers as being facilities that aren't open. How should we think about the incremental impact divided between those two areas?

Jim Reagan (CFO)

Seth, think about roughly half of the 300 as being incremental impact from COVID-19, with a little under half of it being the delay of the NGEN ramp-up because of the ongoing protest activity there. The balance of it would be COVID-19 impacts in other parts of the business, such as the civil business and other parts of the defense solutions segment.

Seth Seifman (Analyst)

Okay. It sounds like then you don't really see that on the intelligence side and the impact of the pandemic on secure facilities. It sounds like that you don't see very much incremental impact there.

Jim Reagan (CFO)

Not that much incremental. The bulk of the incremental impact is being seen. The largest single piece of it is being seen in the health business.

Seth Seifman (Analyst)

Okay. Great. Thanks. Thanks very much.

Roger Krone (Chairman and CEO)

Okay.

Operator (participant)

Our next question is from the line of John Revive with Citigroup.

John Revive (Analyst)

Good morning, John.

Roger Krone (Chairman and CEO)

Hi, John.

John Revive (Analyst)

Hey. Thank you very much for that. Sorry about that. Just, Jim, some of those cash moving pieces heading from this year into next year, I think you got some sort of almost one-time transient items helping you get to the $1.2 billion or greater this year. Can you just help us think about what the moving pieces are going forward, some of those tax items perhaps that go back, how sustainable the AR factoring is, etc., etc.? Thank you.

Jim Reagan (CFO)

Sure. First of all, we expect to leave the AR monetization program in place, and there is some more possibility there to the extent that we need additional funding from it. It is a very low-cost mechanism for us to use, and it is ready for us anytime. The other moving parts in getting us from the $1 billion to the $1.2 billion number on the change in guidance, there is, as we mentioned earlier, the Dynetics impact. That is cash in the bank today. There are also some positive impacts from the CARES Act on how we pay taxes. We have been able to defer the payment of both income and payroll taxes, primarily payroll taxes into next year. A portion of the deferral of our income taxes is simply moving it into Q3, Q4.

Think of the tax benefits into next year as being over $100 million, and then the balance of the changes are primarily driven by COVID-19 impacts being an offset to the tailwinds that we're seeing on cash flow.

John Revive (Analyst)

Understood. Should we be prepared for operating cash flow to fall year on year in 2021? If, to the extent that the CARES Act items are offset by COVID, we could actually grow off that $1.2 billion in 2021?

Jim Reagan (CFO)

Some of the tax benefits will be offset next year and into 2022. The only other headwind that I think we can anticipate from a cash flow perspective is that we expect the business to grow nicely into 2021. In the past, we've said high single digits, but now that we've got some significant backlog from the health business and other parts of the defense solutions business for work that's going to carry into 2021, that's how we get to some confidence around 10% or better in terms of our top line next year.

John Revive (Analyst)

Thank you.

Jim Reagan (CFO)

Thank you.

Operator (participant)

The next question comes from the line of Peter Arment with Baird.

Peter Arment (Analyst)

Yes. Good morning, Roger. Jim, Peter.

Roger Krone (Chairman and CEO)

Hi, Peter.

Robert Spingarn (Analyst)

Good morning, Peter.

Peter Arment (Analyst)

Hey, Roger. Just maybe just without getting into maybe specific dollar numbers, but when we think about the security detection and automation kind of revenue profile, now that you've kind of been deeper into this business and seen the impacts of COVID or had conversations with customers, how do we think about this business as we go into 2021? Is it a business that's growing? Or maybe just give us some color around the health of the business?

Roger Krone (Chairman and CEO)

Boy, I'd love to. By the way, they are ahead of our plan. We had an internal plan that we put together for the combined business, which included the Tewkesbury business and the business in the U.K. that makes the tray return systems. They had a quarter that exceeded our expectations, and we expect that to continue. I know in the last call, we talked about what's going on at airports and if this is going to have sort of a quieting effect on that business. Our speculation was that airports are going to use this period of time to do capital improvements. We've certainly seen that. We've also seen airports wanting to add social distancing and health and safety to the screening and the checkpoint.

If you have to stand six feet apart, you've got to redesign the checkpoint, which means you might need more lanes. You're certainly going to need places for people to stand, the antimicrobial trays, putting ultraviolet light in the return path for trays, doing touchless screening and looking at people's IDs. There's just a lot of opportunity to grow the business beyond what we had anticipated when we built our original business case last year to acquire the business. The team there, led by Maria Heden, has been doing a great job of reaching out globally to customers. We are in 150 or more countries now. Really, across the board, we've seen a lot of interest in capital improvements. We would tell you that rebound has probably started a little stronger outside the United States.

We're still sort of dealing with this kind of resurgence this summer, but in many of our foreign markets, they have had stricter lockdown on the pandemic, and therefore their numbers are smaller. They are implementing biometric concepts at their airports. We're very, very pleased, and the integration is going well. It is, like I said, ahead of our business case.

Operator (participant)

Appreciate the call. Thanks. The next question is from the line of Edward Case with Wells Fargo.

Edward Case (Managing Director)

Hi. Good morning. Can you talk a little bit about your recompete exposure for the rest of this year as well as 2021, please? Thanks.

Jim Reagan (CFO)

Yeah. Thanks, Ed. There are kind of three that we talk about. We've got our what we call our NASA NIST program, which has been submitted. We have two more that have not been submitted. We've got one at NGA, we call our user-facing and data services contract. It's probably the largest that's up for recompete. It's about $4.4 billion. We should submit that towards the end of the summer. We have the IT services work that we do for the Army Corps, we refer to as ACE IT. That's a proposal that ought to submit also at the end of the summer. It's going to be at $1 billion plus.

The only one that's actually been submitted is our FAA NISC, which is the National Aerospace Systems Integration Support Contract, where we are the incumbent. We're actually the incumbent on all three of those.

Edward Case (Managing Director)

Is 2021 a normal 20-25% year, or is there anything unusual there?

Jim Reagan (CFO)

Yeah. Very normal. There's not a Hanford out there.

Edward Case (Managing Director)

You mentioned you were seeing issues in clearances. We hadn't really been hearing that from some of your competitors. Is there anything unique about the mix of your business that's challenging you more?

Jim Reagan (CFO)

I think what may be unique for us, by the way, is primarily in our intel business. It is the very high-end clearances, often requiring a polygraph. I think the background investigations seem to be going okay. I think the problem is I do not want to get into too much detail, but if you have ever been through a polygraph, you know it is a very COVID-unfriendly process in how that is conducted. The throughput that the agencies have on getting polygraphs done has slowed down. It is uniquely in our intel business. I think why it affects us maybe more than others is because of the wind and the growth that we have had. We are not trying to maintain staff. We are actually trying to significantly increase the staff in our intel business because of our winds.

That means we have to get new people through the clearance process and able to support our growth. Not reflecting on some of the others that have reported, our clearance process is not about our current workforce or really predominantly in what we call our collateral clearance, which you might see in our defense group like a secret or a top secret. It really is in that high-end group.

Edward Case (Managing Director)

Great. Thank you.

Operator (participant)

Our next question comes from the line of Joseph Denardi with Jefferies.

Joseph Denardi (Analyst)

Yeah. Good morning.

Jim Reagan (CFO)

Hi, Joe. Good morning.

Joseph Denardi (Analyst)

Hey, guys. Jim, just in terms of 2021, is the thinking maybe that half of the growth is NGEN and half is all else? Just in the context of you're sitting on a trillion-till month book to bill 1.6 times X NGEN, which would speak to really strong, maybe double-digit growth by itself. Why can't growth be better than 10%? Do you see kind of a multi-year period beyond 2021 with really strong growth given the backlog? Can you just update us on the pipeline of bids that you're expecting? Thank you.

Jim Reagan (CFO)

Sure. First of all, Joe, thanks for the question. Speaking first of the pipeline, the pipeline of new business opportunities continues to grow. Interestingly, it is growing with a lot of programs where, first of all, we still have plenty of billion-dollar-sized programs in the pipeline, but there is also continuing growth in the size programs that are in the hundreds of millions of dollars. It gives us greater diversity and greater opportunity. To your question about where the is half of the growth coming from NGEN, the answer is really no because the NGEN program will take some time during 2021 to ramp up. The growth of the business, your point is well taken that it could be better than 10%, but it is our habit to be pretty careful and conservative in putting out those kind of targets this early in the cycle.

Last point that I would make is that as we get to the back end of COVID and our customers are more comfortable with the protocols that we're putting in place to protect patients and people undergoing these exams, we expect that we'll be back on the path to the health group's prior stature as being the part of our business that has the highest margins and the highest growth rates. While the defense solutions segment is going to enjoy nice growth from the NGEN program, we're looking forward to seeing the health group get back to healthy margins and healthy growth rates in 2021.

Joseph Denardi (Analyst)

Yeah. That's helpful. Then just along those lines, in terms of the expectation that the business kind of gets back to normal by Q4, do you have visibility into that, or is that more kind of hopeful in nature at this point? I understand things are fluid. Are you having customer conversations that give you confidence around that, or are you able to kind of change certain processes that lessen your exposure to kind of what you've been facing the past few months? Thanks for the time.

Jim Reagan (CFO)

Yeah. It's more the latter. We already sit today in a better position where both the commercial and the government customers have allowed us to reopen clinics. We have put social distancing, non-contact in place. People are coming back to the clinics. We're seeing the volume increasing. It just did not increase in the Q2. Because we're now using PPE, we're having people wait in the parking lot before they come in for an exam. We're not at the same number of exams per day as we were pre-COVID. That is going to take another quarter or so to ramp back to where our capacity is, where it was pre-COVID on a clinic-by-clinic basis. As I said, I think we're about 85% on the clinics that are open. We expect it to be fully open in this quarter. Then we've got to get our capacity up.

You can only work so much overtime to get the number of exams done per day. We are all learning how to be more efficient in this COVID-19 environment. Clearly, post-vaccine will be either back or better than we were pre because we are learning how to be more efficient and how to do some exams by telehealth, which was not a big part of our business prior. That allows us to have more capacity through a given site. The customers across the board, corporations, government agencies, are all very eager to work with us because the backlog is not good. It is not good for them.

Very real mission impacts because of the need to partially close their work locations. They are eager to work with us to get people back in those work locations. That is a process that is currently underway. Last point that I would make is one of the things that we have learned from how we have had to operate, we have reduced our cost structure. When you take the Vernetix settlement and when you take out the COVID-19 impacts to the business that are arguably temporary, the business had a 10.9% EBITDA margin in the quarter. While EBITDA margins go up and down from quarter to quarter, we do feel confident that on an ongoing basis, what this has done is we have leaned out the business even further than we have, which gives us strong visibility into good margins into 2021 and beyond.

Joseph Denardi (Analyst)

Very helpful. Thank you.

Jim Reagan (CFO)

Thank you, Joe.

Operator (participant)

Our next question is coming from the line of Matt Akers with Barclays.

Matt Akers (Analyst)

Hey. Good morning, guys. Thanks for the question.

Roger Krone (Chairman and CEO)

Hey. Good morning.

Matt Akers (Analyst)

I wonder if you could comment. Good morning. I wonder if you could comment just on what you're seeing kind of early Q3. Is typically the big order quarter for the year. I mean, are there any signs that this will be any slower than prior years, or are things sort of customer demand sort of holding up?

Roger Krone (Chairman and CEO)

There's really no reason why it should be different than any other prior year. I would simply point out, frankly, because of our success and the wins, we are also very successful in attracting protests and adjudication of the quarter federal claims. That has somewhat spread our 3Q. We've got a couple of programs that have been in protest. They come out of protest. They get corrective action. We have to resubmit. I think we might have seen a lot more concentration exactly in 3Q. We've seen some of that spread a bit. We think next gen, probably oral arguments are in October. That won't get resolved probably for a month after that. We have a program we call the Reserve Health Readiness Program, which is a large program to provide services to the military reserve. That is in corrective action.

We have to go through a resubmit, which we have done. Then they have to adjudicate and make an award. That could be Q3, but it's always hard to predict what happens in the protest world. There is nothing unusual about this year that says Q3 should be any different than prior year quarters.

Matt Akers (Analyst)

Got it. That's helpful. I guess one more, just on tax. With, I guess, R&D going from expensing to amortizing over multiple years, I think in 2022, can you give kind of what the impact of that could be on Leidos?

Roger Krone (Chairman and CEO)

Yeah. We're actually looking at ways that even with the change in the law, we're going to be able to recognize more of the work we do as eligible for the R&D tax credit. I don't have a precise number for you, but we're not viewing it as something that's going to have a big impact or material impact on our effective tax rate. This year, we've done a really good job of identifying things that are eligible for not just the R&D tax credit, but even more importantly, in connection with the acquisitions that we've done, being able to take part of the ascribed value of the business and make them tangible personal property that is eligible under the accelerated depreciation rules that came with the recent Tax Reform Act.

We think that there's some opportunity there to improve the cash tax position, not just from how we can optimize R&D, but even more importantly, get more benefit from the acquired companies.

Sheila Kahyaoglu (Analyst)

Got it. All right. Thank you.

Roger Krone (Chairman and CEO)

Thank you.

Operator (participant)

Thank you. We've reached the end of the question-and-answer session. I will now turn the call back to Peter Berl for closing remarks.

Peter Berl (Head of Investor Relations)

Great. Thank you, Rob. Thank you all for your time this morning. If you're interested in Leidos, we look forward to updating you again soon. Have a great day.

Operator (participant)

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.