Leidos - Earnings Call - Q3 2020

Transcript

Operator (participant)

Greetings. Welcome to Leidos Q3 2020 earnings call. At this time, all participants are in 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 star zero from your telephone keypad. Please note that this conference is being recorded. At this time, I'll turn the floor 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 Q3 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 2 October 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 was 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 (CEO)

Thank you, Peter, and thank you all for joining us this morning for our Q3 2020 Earnings Conference Call. As we near the end of a challenging year from both an individual and community perspective, I sincerely hope that each of you and your loved ones remain safe and healthy. Leidos's Q3 results reflect the hard work and dedication of our employees and close collaboration with our customers as we provided continuity of operations while accelerating our pandemic response plans. This is evidenced by record revenue, solid margins, record backlog, and record operational cash generation. While challenges still remain, we're pleased with the growth in margin trajectory as we enter the Q4 and beyond. In the quarter, the business delivered revenue of $3.24 billion, a new high watermark for the corporation, reflecting 14.4% growth from the prior year.

Adjusting for acquisitions and divestiture activity, organic revenue grew by almost 2%, demonstrating the declining effects of COVID-19 as our teams diligently executed their recovery plans. We recorded non-GAAP, fully diluted earnings per share of $1.47, up 8% from the prior year. In addition, the business generated a record $592 million of cash from operations. Net bookings of $4.3 billion in the quarter yielded a book-to-bill of 1.3x, as well as 1.5x on a trailing 12-month basis, despite several bid protests at the end of the quarter. Adjusted EBITDA margins of 10.7% reflect strong program execution across all business segments, including an accelerated reopening of our medical exam business as we designed workflow protocols and safety measures that met customer requirements.

While the impact of maintaining our fixed-cost exam infrastructure was deeply felt in Q2, that investment was the right decision as the market demand for our services rebounded well in the Q3, as demonstrated by our results. For the quarter, COVID-19 impacts to the overall business were approximately $109 million in revenue and $23 million in operating income, representing a significant decline from the prior quarter's impact of $223 million and $78 million, respectively. Furthermore, Q3 impacts were partially offset by program performance and on-contract growth across our highly diversified portfolio. We continue to expect recovery of greater than 70% of COVID-19 impacts in future quarters. Now turning to some notable awards that contributed to our ninth consecutive quarter of record backlog.

In the Defense Solution segment, Leidos was awarded a $306 million follow-on contract by the Army Contracting Command to provide the full spectrum of turnkey ground and flight operations for the Saturn Arch aircraft in OCONUS contingency environments. In the civil segment, we won a $292 million prime contract by the Federal Aviation Administration to design and develop a system to provide real-time access to essential weather, aeronautical, and national aerospace system NAS information through a common NAS-wide enterprise information display system. Additionally, within the intelligence community, the company was awarded contracts collectively valued at $445 million, which encompass mission-critical services that help to counter global threats and strengthen national security. Our $31.7 billion backlog, about 2.5x our Q3 annualized revenue run rate, coupled with our strong new business pipeline, provides a strong foundation for accelerated growth into next year and beyond.

Furthermore, our backlog does not reflect recent awards with the Defense Health Agency and the Army Special Operations Command due to protest activity at the close of the quarter. Similarly, the $8 billion Navy NextGen protest remains in the U.S. Court of Federal Claims with oral arguments now scheduled for 13 November. We still anticipate a favorable outcome shortly thereafter. Now turning to the macro environment, the U.S. government is currently operating under a continuing resolution through 11 December, which includes an extension of Section 3610 of the CARES Act. It is likely that the CR is extended into the next calendar year. We do not anticipate any material impacts to our 2020 year-end results. Furthermore, we remain engaged with our industry partners to help ensure that extension of the CR also includes the existing Section 3610 language.

Looking to 2021 and beyond, we continue to have conviction that our positioning in infrastructure, space exploration, and healthcare in the federal civil markets and in unmanned systems, hypersonics, and digital modernization in the defense and intel markets closely aligns with our customers' enduring needs, which are supported by both sides of the aisle within the federal government. Next, I want to update you on the Leidos Relief Foundation, which has been a tremendous resource for so many members of our Leidos family who have been affected by the pandemic. The foundation is generously funded by hundreds of fellow employees, as well as members of the Leidos executive leadership team and board of directors. To date, funds from the foundation have already been directed to assist 175 employees or employee families who have experienced a financial hardship or lost a loved one during these challenging times.

The health and well-being of our employees is our top priority, and I am proud to be part of a team that continually supports one another. I want to mention one other important development to you today. On October 20th, we announced the departure of a valued colleague from our board of directors, Lawrence C. Nussdorf. Larry stepped down from the company's board of directors for medical reasons effective 15 October. Larry has dedicated more than a decade of service and leadership to our company, seeing us through transformational change growth and helping create enviable shareholder value. He has accelerated our strategies and added value at every turn. Recognizing that Larry is irreplaceable, our board decided to eliminate the vacancy caused by his departure, and we will carry on with 12 directors.

To say that we will miss Larry is an understatement, as his expertise in all aspects of financial investment and legal activities gave us a sounding board we could always rely on. I am personally thankful for his friendship and counsel. At times, he has challenged me, and I have grown because of it. I am incredibly appreciative of his mentorship and friendship, and I did not want to close today without acknowledging his many contributions. We wish Larry and his family well as he focuses on his recovery. I will now turn the call over to Jim Reagan, our Chief Financial Officer, for more details on our Q3 results and guidance.

Jim Reagan (CFO)

Thanks, Roger, and thanks to everyone for joining us on the call today. In the interest of getting to your questions, I'll focus my comments on our solid Q3 results and full-year guidance. Q3 revenue was strong, growing 14% over the prior year period, including 1.7% organically. In addition to contributions from recent acquisitions, our growth was primarily fueled by recent program wins and on-contract growth, plus our ability to accelerate the reopening of medical exam clinics, which is a part of our business with high operating leverage. Today, we are performing at volumes that exceed pre-pandemic levels to address the backlog of medical exams that had built up during the Q2. These increases were partially offset by $109 million of COVID-19 impacts, comprised of approximately $40 million of year-over-year impacts, plus $69 million of anticipated growth that we would have achieved on existing and new programs.

Adjusting for the impact of COVID-19 on the quarter, organic revenue growth would have been roughly 5.5%. Adjusted EBITDA margins were also strong, at 10.7%, consistent with the prior year period in spite of a $23 million COVID-19 headwind to expected growth. This compares well with our prior year adjusted EBITDA margin of 10.7%, which had been assisted by the $54 million Greek arbitration award. Our robust margins this quarter were driven by exceptional program execution and indirect cost management across all of our segments. Non-GAAP diluted EPS of $1.47 exceeded our expectations, growing $0.11 over the prior year period. Our strong program performance and increased volume on existing and new programs, partially offset by higher interest expense, drove the 8% growth year-over-year.

Record-high operating cash flows of $592 million for the quarter were driven by strong operational performance across the enterprise, higher customer advance payments, and favorable timing of vendor disbursements. The AR monetization facility contributed only $7 million during the quarter. Keeping with our disciplined capital deployment strategy and our commitment to de-lever, this quarter we used cash on hand to pay down $477 million of debt, retiring a $450 million senior unsecured note three months early. Additionally, in October, we completed a $1 billion bond deal that benefited us in three ways. First, enabled by our investment-grade credit rating, we were able to capitalize on favorable market conditions by securing lower long-term interest rates. Second, we replaced certain debt instruments with ones with extended maturities.

Lastly, the deal provided our balance sheet with greater near-term liquidity that allows us to take advantage of smaller tuck-in acquisition opportunities where speed of execution provides us with an advantage. As of the end of the quarter, our adjusted net leverage was slightly above 3.0, which was a goal we had previously set for early 2021 after we completed the two acquisitions earlier this year. Having reached our target leverage, we remain committed to our long-term balanced capital deployment strategy, which consists of being appropriately levered and maintaining our investment-grade rating, returning a quarterly dividend to our shareholders, and reinvesting for growth both organically and inorganically, and returning excess cash to shareholders in a tax-efficient manner. Bookings of $4.3 billion were strong across all segments and resulted in a 1.3x consolidated book-to-bill, with record backlog ending the quarter at $31.7 billion.

This record backlog reflects a 33% increase over the prior year period. It's also worth noting that excluded from our book-to-bill and our backlog is the impact of $9 billion of contract awards that are currently under protest. Now for an overview of our segment results. Defense Solutions revenue increased 22% over the prior year and 3.5% organically. Driving this growth was the Dynetics acquisition and the strong execution of new programs, partially offset by COVID-19 impacts of $26 million from reduced volumes on legacy programs and $14 million from expected growth. Non-GAAP operating margins in the Defense Solutions segment of 8.8% grew 110 basis points from the prior year quarter. Contributing to the increase was the Dynetics acquisition, new program wins, and reduced indirect spending, partially offset by impacts due to COVID-19, including the effects of maintaining mission-essential personnel in a ready state for key customers.

Defense Solutions booked over $1.8 billion in net awards, resulting in a book-to-bill of 0.9x for the quarter and 1.2 on a trailing 12-month basis. In our civil segment, revenue grew 5.2% over the prior year period and contracted 4.9% organically. The top-line growth was driven by the acquisition of the Security Detection and Automation businesses. This increase was offset by COVID-19 impacts consisting of $14 million from reduced program volumes and $38 million from expected growth on existing and new programs. Civil non-GAAP operating margins of 10.5% increased 220 basis points over the prior year quarter. The primary drivers were increased volumes on mature programs and a decrease in bad debt expense that reduced the prior year's Q3 results. Civil recorded nearly $1 billion in net bookings for the quarter, resulting in a 1.3x book-to-bill and 2.4 on a trailing 12-month basis.

Finally, turning to our health segment. Health segment revenues increased 2.4% over the prior year quarter and 30% sequentially. Additionally, after adjusting for acquisition and divestiture activity, health revenues grew 5.8% organically. This growth was directly attributable to the hard work accomplished by our team to both reopen and ramp the medical exam business back to pre-COVID levels faster than previously forecasted. Health segment non-GAAP operating margins were strong at 16.3%, an increase of 150 basis points over the prior year quarter, reflecting the accelerated recovery in our medical exam business, the divestiture of the health staff augmentation business in the Q3 of 2019, and a reduction in business investments. The health segment booked over $1.5 billion in net awards driven by an increase to backlog in the medical exam business based on sustained elevated case deliveries and demand.

This 13% growth over the prior year period resulted in a 3.0 book-to-bill for the quarter and a 1.0 on a trailing 12-month basis. Moving now to the remainder of the year. With the strength of our Q3 results, we are revising our 2020 guidance as follows. We expect revenue for the year to be between $12.3 billion and $12.5 billion, reaffirming the prior midpoint and tightening the range. This update reflects the execution of our strategy outlined in the Q2 earnings call and returning to normalized run rates and business mix in the Q4. We expect adjusted EBITDA margins for the year between 10.6% and 10.8%, a 60 basis point increase at the midpoint from the previous guidance. This reflects the improved margins in the Q3 from high staff utilization, reduced indirect costs, and strong program execution across the entire business.

We now expect non-GAAP diluted earnings per share between $5.65 to 5.85, an increase of $0.35 at the midpoint of the prior guide. Finally, we expect cash from operations to be at least $1.2 billion, consistent with the prior year, gives us increased confidence that we will have a strong 2021. Assuming continued success in defending the awards that are in protest and our customers' continued ability to adapt to the pandemic, we could achieve organic revenue growth in 2021 of at least 10% to 12% and adjusted EBITDA margin of approximately 10.3% or better. As is our normal business practice, formal 2021 guidance will be discussed at our Q4 earnings conference call. With that, I'll turn the call 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 star one from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. Thank you. Our first question today comes from the line of Joseph DeNardi with Stifel. Please proceed with your questions.

Joseph DeNardi (Analyst)

Oh, thanks. Good morning.

Roger Krone (CEO)

Hi. Good morning, Joe.

Jim Reagan (CFO)

Hey, Joe.

Joseph DeNardi (Analyst)

Yeah. Good morning.

Jim, can you maybe just provide some of the puts and takes that go into the margin commentary for next year that you just talked about? Maybe what are some of the headwinds? How much of that is tied to COVID versus newer opportunities ramping up? Thank you.

Jim Reagan (CFO)

Sure. For next year, Joe, we do not see a significant headwind related to COVID. You know, as we have said in the call, we are really finding ourselves with a reduction in run rate and indirect expenses, strong program execution. In terms of how we are thinking about next year, I want to make sure I reiterate the fact that this is really preliminary, and it is based on where we see the numbers penciling out for next year. We are right in the middle of our planning process. You know, right now we are seeing some ability to sustain the strength in margins that we are seeing in the Q3. The only real headwinds that are worth pointing out right now that we have to be cognizant of is that we have a couple of very large new programs ramping in the coming year.

As we've said before, typically, margins on those programs can be as low as low single digits. We think of our entire company as a portfolio of programs. While there are a number of programs that have margins that continue to increase, we do have a couple of big programs where we have early-stage margin pressure that typically starts to resolve itself after the first couple of years of these long-term programs. That's really what that reflects. You know, we feel like, given the portfolio that we have, we're definitely going to be seeing strengthening margins into next year.

Joseph DeNardi (Analyst)

Okay. That's helpful. Then, Roger, I'm wondering if you'd just talk about kind of the overall award environment. Book-to-bill was maybe a little seasonally light. You're not alone. Some of your peers have reported similar. Are you—did you see any kind of slowdown in the quarter, or do you see pent-up demand over the next few quarters? Thank you.

Roger Krone (CEO)

It may be a little. There's—we have a program with the FAA that, you know, we say it's going to award any week, and then we don't know which week. I think our book-to-bill was probably impacted more by protests. One of those programs was pro—this was the second protest. And, you know, we had sort of hoped that we had answered all the issues from the first protest, and we were optimistic that we would have booked that in the quarter, and it turned out that that didn't happen. And then, maybe, NextGen got delayed about another two weeks. You know, I just—there's always some delays to the right, you know, even in good times before COVID. You know, within a given month, it's a little bit unpredictable.

With the government's fiscal year, there was stuff that was trying to get out within the quarter, and it slid. We think we'll pick most of that up in Q4. We haven't seen from the customer activity, like, an effect from, I don't know whether we call ourselves in a second wave or third wave or whatever you want to call where we are now. It's certainly, you know, I don't see things accelerating, but I think they're kind of going at the usual pace. For us, really, the 1.3 really is a protest story. Thanks, Joe.

Joseph DeNardi (Analyst)

Yeah. Thank you.

Operator (participant)

Our next question is from the line of Seth Seifman with JPMorgan. Please proceed with your questions.

Seth Seifman (Analyst)

Hey, thanks very much, and good morning.

Roger Krone (CEO)

Morning, Seth.

Seth Seifman (Analyst)

I wonder in that—morning. In that outlook for next year, in terms of how you think about the duration of a continuing resolution and at what point it starts to, you know, have an impact given that we could have an extended one following the election?

Roger Krone (CEO)

Yeah. Our base assumption is that we get another CR on the 11th of December. It includes 3610, and frankly, it probably goes till March. We get through whatever happens tomorrow, and that's its effect on January. You know, it's either the current administration, and they have a lot of vacancies they want to fill, or it's a new administration. They've got vacancies. I think our assumption is, you know, they're going to see out of their way all the way through that until they fill out their leadership team. It could be March, could be even beyond that. There are precedents for this. We've seen it before. It's fully baked into our thoughts about the future, and that means you'll be halfway through the government fiscal year before you actually get a bill.

Again, you know, we've all been doing this a long time. We've seen it before. Frankly, you know, there may even be an advantage is because if we get a CR, then everybody holds onto the budgets that they had last year, and you don't see a lot of reprioritization amongst different programs at different agencies. No, I don't see much impact.

Seth Seifman (Analyst)

Great. Thanks. If I could just follow up quickly on the two acquisitions and your contributions in the quarter, really nice sequential pickup on Dynetics and just, you know, how things are tracking there, versus your expectations for the year and into 2021. Then, slight sequential step down in the airport security products and kind of how things are shaping up there given, you know, what's happening in the air travel environment.

Roger Krone (CEO)

Yeah. Look, I'll do sort of the qualitative, and if Jim wants to put a little bit of quantitative out there, he can. Let me start from the active integrating. Okay. That's, you know, back office systems people. And both Dynetics and the Security Detection and Automation business are doing really quite well. I mean, we're ahead of our milestones. We're getting systems converted, people converted to our employee system. And so that's going really, really well. From a leadership standpoint, we're just really pleased and excited that the leadership team of both organizations have continued to stay. We're very happy that we've literally—we lost nobody off of either senior leadership team. The Dynetics business, because of Lander and some other things, is ahead of our expectations. And, you know, we integrated them with our Leidos Innovation Center.

And, you know, that has really created some cross-linking into our existing R&D business, which is really, really exciting. You know, I think you touched on what's going on in air traffic. You know, we were over a million passengers like two weeks ago, and then this sort of second wave has tempered that a little bit. We've got a couple foreign bids that have gotten delayed by a couple weeks. You know, TSA has actually moved forward with some CT at the checkpoint opportunities. Our expectation is, it's going to be a long recovery, and orders are going to stretch to the right. There is, I think, a cause to have a balanced view of our Security Detection and Automation business.

By the way, for us, that's almost good because we get a chance to really focus on integration and, you know, get those systems and processes into what we call the Leidos business framework and where we want them before we see any significant ramp-up. We've seen air traffic. I think the U.K. just went on a month's shutdown. This second wave, third wave is going to be problematic. I think we're very circumspect about that and its effect it'll have on our business. A great opportunity for us to get our CT product to the market and to get things through the qualification process with TSA. Again, we're very excited about that business. It's just, we're in the middle of this, you know, second wave in the pandemic. Jim, I don't know if you want to talk about numbers.

Jim Reagan (CFO)

Just to amplify what you said, Roger, the Dynetics business is performing, in some metrics, better than we expected on some. We're spot on, and we're pleased with how that business is accelerating through integration. As you said, that's tempered with, you know, the other acquisition, which is seeing some of the COVID-19 impacts, not so much with win rates, but more how some awards and some deliveries have been pushed out as a result of the pandemic. Thanks.

Seth Seifman (Analyst)

Great. Thank you very much.

Jim Reagan (CFO)

You're welcome.

Operator (participant)

The next question is from the line of Matt Akers with Barclays. Please proceed with your questions.

Matthew Akers (Analyst)

Hey, good morning, guys. Thanks for taking my question.

Jim Reagan (CFO)

Good morning, Matt.

Matthew Akers (Analyst)

I wanted to follow up real quickly on the CR commentary and specifically the 3610 extension. I just wanted to ask kind of how important is that specifically? I think, you know, based on some of the commentary from some of your peers, I think it sounded like a lot of people covered by 3610 had already sort of returned to work. If you could just comment on sort of how big that is for you at this point.

Roger Krone (CEO)

Yeah. I'm happy to share our numbers. Ninety-seven percent of our team is back at work on regular hours. We have really only about 1.5% at a reduced standing, and that's the people that would really be affected by 3610. Then we have a 1.5% that's kind of miscellaneous, just some structural things. It's really not a big impact for us anymore. I think that's, you know, we've seen that across the industry and certainly our peers in these agencies. I think there are some things around 3610 that may be more important for some of the bigger aerospace primes relative to factories and things.

That does not affect many of our programs because of the nature of our work, which is really people coming to work and, you know, writing software and doing mission and things like that. Not as important as it was, you know, at the beginning of this journey. It would still be nice to have, but, you know, we do not see a major impact.

Matthew Akers (Analyst)

Okay. Thanks. That's helpful. I guess if I could just one more on sort of budget risk next year. I think that that's kind of the biggest concern I see from investors. You know, I guess if you just sort of look across your addressable market, are there certain areas that you think are maybe more susceptible to budget cuts as you look out over the next couple of years as opposed to, you know, maybe other areas that you think are more well protected? How do you think about sort of positioning Leidos within that?

Roger Krone (CEO)

Yeah. And, you know, we've talked about it at the last quarter. And, you know, I'll just reiterate some of our themes. You know, if you're in support of legacy programs within DOD, I mean, that's probably not a great place to be. You want to be in the emerging technologies, I think, regardless of who gets elected. The Biden campaign has, you know, come out and said, you know, that they're not looking to cut defense. And we think that's true. That means that they're not going to cut it. They probably wouldn't grow it as fast as a second Trump administration would. They're shifting our priorities. You know, I think Biden is going to kind of go back to international alliances and, you know, maybe reopen trade.

I think Trump will continue what he has done. We think in any administration, you know, pandemic response, healthcare, civil infrastructure, we think our return to the moon program is strongly supported, by the way, from both sides of the aisle. Both administrations have said that. I've said this in many, many calls, you know, everybody gets elected or reelected, you know, with hopes and ambitions and a set of priorities. Then you walk in the office, and you're faced with a record deficit, you know, is 8% to 9% unemployment. You know, you're on the precipice of a recession. I think either administration is going to look for another CARES relief act.

I think the tax increase, which is purported in the Biden administration, will be delayed because the last thing I want to do is tamp down economic growth because that's how we pull ourselves out of this large unemployment. I actually think that, you know, 2021 looks a lot like 2020, and 2022 is already in planning. It's in what we call the POM and EPP cycle. If you talk to customers, they've already put their budgets in for 2022. Of course, our backlog takes us well into 2023 and 2024 before our programs start to be affected. There will be changes in priorities, more civil infrastructure.

You know, I think we've got to get pandemic response ready, and that's CDC and organizations like FEMA and NIAID and USAID and NIH, all of which we have been, you know, carefully positioning the company, with a balanced portfolio to be able to address what would be a shifting priorities in the federal government. We are very happy with where we're positioned. We're going to continue to, you know, stay up late tomorrow night and see who got elected. I think we're going to be in great shape either way.

Matthew Akers (Analyst)

Great. Thank you.

Roger Krone (CEO)

Yeah. Thanks, Matt.

Operator (participant)

Our next question is from the line of Sheila Kahyaoglu with Jefferies. Please proceed with your questions.

Sheila Kahyaoglu (Analyst)

Hi. Good morning, Roger and Jim.

Roger Krone (CEO)

Hey, good morning, Sheila.

Sheila Kahyaoglu (Analyst)

Roger, don't tell us 2021's going to look like 2020. I don't think anybody wants that, so.

Roger Krone (CEO)

Yeah. Great point. Absolutely great point.

Sheila Kahyaoglu (Analyst)

I wanted to ask first on revenue drivers in defense and civil. What's going on in those businesses? I appreciate the ex-COVID impact. They were up 6% and 2% organically. What are some of the puts and takes, and how do we think about those going forward?

Roger Krone (CEO)

Hey, Sheila, before Jim answers that, I'll just comment. When the kids come around on Halloween dressed as a calendar named 2020, you know nobody wants to repeat what we did this year.

Sheila Kahyaoglu (Analyst)

Exactly.

Jim Reagan (CFO)

Yeah. In particular, defense and civil revenue drivers, both actually for, you know, the back end of this year and into next, some program wins that represented takeaways, and growth in existing programs, are really the drivers. We had an Air Force takeaway, for example. I'll just give you a couple of examples. You know, something called ACC ISR, which was a takeaway. There's a contract in CBP that is a traveler vetting system contract that we won. These are the kinds of things that are providing us organic growth. Again, that's in the defense business. If we want to think about it in, you know, in the civil, inorganically, obviously, it's SD&A. There's also some growth of existing programs that we're looking at for next year in the DOE. The NETL contract is one example.

We have some expansion in our MSA contract there as well. Those are the things that have been driving revenue growth. You know, probably also interesting is margin expansion that we're seeing both in those two businesses and really across the whole portfolio. That has to do with really strong program performance and effective management of indirect costs as we kind of work through the pandemic. These have been things that have more than offset some of the headwinds that we've had from COVID-19. It really is a testament to the program teams and the management team that are out there driving those improvements.

Sheila Kahyaoglu (Analyst)

Okay. Thanks, Jim, for that. And then one more for you, because we can't seemingly keep up with your puts and takes for free cash flow.

Just to clarify on the because of the pre-funding of the billion-dollar bond or, the financing of that, how do we think about AR for this year? Is it net neutral and how that flows over to 2021?

Jim Reagan (CFO)

Yeah. For the full year, the impact of our AR monetization facility is going to be zero. Previously, we had included in our guidance a $300 million add that shows up in operating cash flow. That is, in effect, the sale of our receivables, at a very, very low cost of capital. We do not need to do that now to maintain the level of liquidity that we want. We have ample liquidity, so we do not need that anymore. You can think about the $1.2 billion guide that we have today as being a $300 million improvement from a performance standpoint versus where we were last quarter.

Sheila Kahyaoglu (Analyst)

Okay. Great. Thank you.

Jim Reagan (CFO)

Thank you, Sheila.

Roger Krone (CEO)

Great. Thanks, Sheila.

Operator (participant)

Our next question is from the line of Cai von Rumohr with Cowen. Please proceed with your questions.

Cai Von Rumohr (Analyst)

Yes. Thank you very much. Could you just refresh us in terms of the Defense Health and the Army SOCOM protests? Approximately how large were they? When do you expect the protest timeline to be over?

Roger Krone (CEO)

Okay, Kai, let me see if I can get these right. First of all, the total number we have in protest is about $9.3 billion.

If you add all the programs that we have collectively, what we call our HRP program is rounded to a billion, give or take a little bit. It doesn't mean that's exactly what we'll book when we achieve the protest. I think that's in January, right, we don't get that till January. The other program, we refer to it as STAMP, which stands on, of course, for something, is about $600 million to 650 million. Of course, you add NextGen to that, at about $800 million, maybe a little less than that, $700 million, $800 million. That gets you to about $9.3 billion. I think the STAMP, we're hopeful will happen in Q4. If it doesn't get reprotested, which we're getting used to, and then maybe NextGen, you didn't ask.

I touched on it in my remarks. You know, we're kind of whether it's before Thanksgiving or after Thanksgiving, it's hard to tell. You know, you do oral arguments. The Court of Federal Claims is not, you can't set your clock by it like you can with the GAO. You do oral arguments, and then we're in the hands of the judge. He can make a ruling anytime after oral arguments, you know, from that day to probably a couple of weeks.

Cai Von Rumohr (Analyst)

Terrific. The second one would be, you know, your margins were good, and you measured, you know, you've talked about the COVID headwind. To what extent do you feel that COVID was a tailwind in terms of indirect expenses benefiting from lower travel and meeting expenses and utilization benefiting from lower paid vacation time off because there were fewer places for people to go?

Roger Krone (CEO)

Yeah. You know, Kai, that certainly was certainly a factor. You know, I don't know whether it's 20 or 30 basis points, maybe something like that. I mean, it's a little hard to put our finger on it, but, you know, clearly made a difference. And our medical costs are down, you know, double-digit millions. The challenge for all of us, by the way, and it's all relatively good. The challenge, I think, for us and for the industry is to decide what comes back and what doesn't. You know, we're at somewhere between 25% and 50% occupancy in our buildings, and we're running just fine. We have 65% of our employees are telecommuting, and they're doing reasonably well, I think, you know, actually very well.

We start to look at 2021 and say, "We need less real estate." We don't need to go to all the trade shows that we've been to, or at least not in person. Some of the virtual work that we've done on AUSA and AFA have worked actually extremely well. We've actually talked to more general officers because you can zoom them, and you can do one right after another, and they don't get caught in somebody else's showbooth, right? We are really taking a look at the lessons learned, and we want to capture and internalize, you know, a significant portion of that reduction in our margin going forward. I think you're seeing that across the board.

Cai Von Rumohr (Analyst)

Terrific. Thank you very much.

Jim Reagan (CFO)

Yeah. Thanks, Kai.

Operator (participant)

Our next question is from the line of Jon Raviv with Citigroup. Please proceed with your questions.

Jon Raviv (Analyst)

Hi. Thank you. I was going to ask Sheila's question, but Jim, since you did not fully answer it, maybe I will take another whack at it. It is just about big moving pieces into 2021. Thanks for clarifying the AR this year. But thinking about 2021 over 2020 cash flow, you know, we are sort of still looking at about $1 billion operating cash. I think that number has been thrown around previously. Or can we actually sustain it as $1.2 billion or greater going into 2021 with all those moving pieces, including, I know, payroll tax and whatnot? Thank you.

Jim Reagan (CFO)

Yeah. John, we'll have more to say about that when we issue our guidance at the end of the Q4 call. You know, we were purposeful in not putting all the details out there because we're still working through that. I would tell you that this year has been benefited significantly by the ability to defer taxes into next year. And we'll have a lot of the moving parts for that available when we give you the kind of a walk of this year's cash flow to next year. Another thing you have to remember is that next year we're not going to have a repeat of VirnetX. That was, you know, $80 million.

You know, the strength of this year's cash conversion has really been on the backs of the CARES Act legislation, VirnetX, strong program performance, and our continued focus on monetizing receivables, getting things billed faster, getting them collected faster. You know, we always have these things that I refer to as recurring non-recurrings, but we just, you know, we can't plan those. You know, who knows what next year's tailwind on cash flow might be. Like I said, we'll have more to say about that in next quarter's call.

Jon Raviv (Analyst)

Yeah. I appreciate that. Thanks, Jim. And then just on your, the incremental debt raise, can you just clarify, you know, how much are you actually taking out with that $1 billion, or is it all just additional? You mentioned your capital plan priorities, but, you know, with that additional debt, you're sort of looking, you know, you mentioned some tuck-in M&A capabilities. What are some of those opportunities that might be out there at this point, size-wise and market-wise and capability-wise? Thank you.

Jim Reagan (CFO)

Yeah. I'll answer the first part of that question, and Roger can speak to the second half about what we might be interested in. Out of the billion-dollar raise, we paid off debt to the tune of $750 million, and we left $250 million in the cash account to give us the kind of flexibility that we're talking about. Roger can speak to the kinds of things that could represent tuck-ins, with, you know, we don't have anything specific, but, you know, like I said, we want to have some flexibility, and that's why we're keeping some cash around.

Roger Krone (CEO)

Yeah. You know, John, we're always, you know, working a pipeline of, you know, where do we want to be? What are the technologies that support the programs that we see three and five years out? Then we take a look internally, within what we call our technical core competencies and whether we're deep enough or not. You know, there tends to be kind of a make-buy decision and time to market. You know, at any given time, we'll have, you know, a half a dozen, you know, $50 million to 250 million deals kind of in a pipeline. You know, some are indulgent, some were just, were wishful. You know, don't really have anything to say at this time. Of course, we never comment on M&A anyway, but I don't think anything that's going to surprise you.

I mean, it's, you know, you've been listening to the calls. You know where we're moving. You know, digital transformation, hypersonic space, cyber, physical cyber, electronic warfare, you know, that the whole list that we've been talking about for a long time. There are some companies that have been in, you know, kind of PE or venture capital that are looking for a liquidity event. By the way, one point I've made before may be interesting to remind everyone. Usually, the companies that we buy, we've had a relationship with for a long time. You know, we do over and under. They might be a sub to us. We've probably been working with these companies for five years, some up to a decade. We know the management team well. We know the technology well, and especially the culture of the company.

You know, culture is really a big thing for us, and we want people that will fit with our organization. You know, we're a little different, because, you know, we're employee-owned for so long. It's sort of a more of an open collaborative culture, and culture is a really big deal for us. And if it doesn't work out, then we're happy to have them, you know, in a partnership relationship going forward. That's kind of what we're looking at.

Jon Raviv (Analyst)

Thank you.

Roger Krone (CEO)

Yeah.

Operator (participant)

Our next question is from the line of Rob Spingarn with Credit Suisse. Please proceed with your question.

Rob Spingarn (Analyst)

Hey, good morning.

Roger Krone (CEO)

Hey, good morning, Rob.

Rob Spingarn (Analyst)

I know you don't want to guide to next year, but you did mention that 10% to 12%. And understanding that there's some moving pieces and delays and protests and so forth, is there a way to talk about that qualitatively by segment?

Jim Reagan (CFO)

Rob, we don't, you know, as we've said before, we don't guide by segment, right? You know, to speak to it qualitatively, it really is based on, you know, we're kind of halfway through or near, you know, maybe 2/3s of the way through planning for next year. The early returns that are coming up from the units are consistent with kind of what the top-down math looks like. You know, strong book-to-bill over the last 12 months. The contract lengths haven't gotten longer. We have some really big, enterprise IT programs that are ramping. And with those, we could easily pencil out growth, to the tune of what we said on, you know, earlier on the call. By segment, you know, today, we're seeing expanding margins across each one of our segments.

We think that next year could have some strong organic growth across the entire business because we're, and we're pleased that across the portfolio, everything has strong book-to-bills, and that translates to strong organic growth next year.

Roger Krone (CEO)

Hey, Rob, let me jump on the back of that. You know, given our last two quarters and what happened in our health business and the amount of time we spent with the community on how the exam business works, you know, and we tried to be as transparent as we could, is that if we get to the point where our clinics are shut down, we can't do exams. We went through that period, as, of course, everyone saw. As we have said, we said on the last call, just to repeat it again, the exams do not go away. Those disability exams, whether Department of Labor or for the veterans or for workmen's comp, still have to get done. We are now faced with sort of an inventory of exams we have to work our way through.

We're fortunate we ended the Q3 at higher than COVID levels, although for the quarter, we were probably kind of at or about where we were before, you know, starting lower, ending higher. We now have to work through that inventory of exams, and that's going to take us well into 2021 to do so. We've tried to be transparent with everybody. When we had to shut down the clinics, what it would look like when we were open, we're now reopened. All of our clinics are open. We still have PPE, and we, you know, have to have appropriate protocols because the pandemic is, you know, clearly alive and well out there. We expect sort of the tailwind, certainly from the exam business, to go significantly into 2021.

Rob Spingarn (Analyst)

Okay. Similar question, maybe higher level and looking at a little bit further, but with the potential changes in strategy, if we have a change in administration, longer term, Roger, how do we think about your service exposure, changing in the defense business? I'm talking about Army, Navy, Air Force exposure. Is that something you can speak about?

Roger Krone (CEO)

Yeah. I'll touch a little bit, and then maybe if we have time at the end, you can ask a second question. You know, I get, you know, I always get wrapped up in when you use the word service, I want to stop and talk about, you know, the lower-end services is not the business that you find that Leidos is in, is that we tend to be mission-focused. You know, we don't do services, right? We do solutions, and we partner with our customers on mission. A comment maybe you were leading to is, you know, like, what'll happen in the AOR in the Middle East? You know, Trump had made a commitment to pull troops down, and there have been troops. We have reduced our footprint in the Middle East.

I think we all anticipated that is likely to continue, I think, under either administration. The number's not going to go to zero. Part of what we do is we provide support not for the U.S. troops, but for the Afghans. Some of our aviation programs are in direct support of Afghan operations by Afghanis. We could see sort of a slowing down of some of the work that we do in theater, which frankly is a wonderful thing. It means we don't have troops at risk. The customers are going to take that obligation authority, and they're going to spend it in other areas. They may spend it in modernization, which is great for us because we're well-positioned in the future of our customers.

What we have all learned is that if it quiets down in Iraq and Afghanistan, it's going to get hot someplace else. You know, unfortunately, history has told us that there's always a place to deploy troops. I would tell you that we have been fortunate to subtly shift our portfolio out of that very, very low end. Our OCO numbers are very small, and so we're fairly well insulated to what I would call that pure services play if that were to be de-emphasized in the budget.

Rob Spingarn (Analyst)

Yeah. What I was thinking about is just if, just, you know, writ large, if Army became a bill payer for growth at Air Force and Navy and in space, clearly at Dynetics, you have very good exposure to all those growing things. That is the way I was thinking about it. That is certainly something that investors are asking us.

Roger Krone (CEO)

Yeah. And again, why do not I let you go, and we will come back. I would simply say, we have not seen it. You know, our support contracts to the Army are doing fine. I think there are some things around Army end strength and, you know, requires a longer conversation. I would rather not, you know, use everybody else's time. Rob, maybe we will call you after the call, and we can talk a little bit more about what we think is going on in the Army.

Rob Spingarn (Analyst)

Okay.

Roger Krone (CEO)

Thanks.

Operator (participant)

The next question is from the line of Peter Arment with Robert Baird. Please proceed with your questions.

Peter Arment (Analyst)

Yeah. Thanks. Good morning, Roger, Jim. Roger, I just maybe just to talk briefly about, kind of a follow-on to Rob's question about 2021, just specifically when we think about the SD&A business, is just to clarify, do we, do is there an expectation that that visibility there in 2021 will actually, we'll see a return to growth for that business? Or how should we be thinking about just the revenue profile of that business?

Roger Krone (CEO)

You know, it's a little early for us to know with specificity that part of what we call our security products business, which is actually being integrated in with the legacy Leidos business. I think that right now we're not viewing that as being a big grower for next year just because of what we think of as kind of the hangover from COVID-19. However, you know, we can probably have more color on that in the next call as we have more visibility into how well the order pipeline is developed.

Peter Arment (Analyst)

Okay. Just as a quick follow-on, just regarding your ability in general to add new hires, in this environment, how has that been proceeding? Thanks.

Roger Krone (CEO)

No, it's been terrific. You know, we went to a virtual hiring platform. We do virtual new employee orientation. We've got employees who are part of the company who are working from home who have never been to a Leidos building. We're very, very fortunate that people see what's going on at the company. They understand our culture. They love the work. They love working together, and they love the workplace flexibility that we now offer. Hiring has not been a constraint for us. Now we were hoping that we would have had Navy NextGen in our portfolio by now. That is going to require a significant, literally above 1,000 people. We hope that will be our problem next year, and we'll add that.

Of course, we've added a lot of people through the acquisitions, the Dynetics and the SD&A. All told, between direct hiring and acquisitions, we'll probably add around 9,000 people this year.

Peter Arment (Analyst)

Terrific. Thanks so much.

Roger Krone (CEO)

Yeah.

Operator (participant)

Thank you. The next question is from the line of Gavin Parsons with Goldman Sachs. Please proceed with your questions.

Gavin Parsons (Analyst)

Hey. Good morning.

Jim Reagan (CFO)

Good morning, Gavin.

Roger Krone (CEO)

Good morning, Gavin.

Gavin Parsons (Analyst)

Jim, just quick one on guidance assumptions. In the last quarter, you guys provided a pretty helpful slide on the sizing of COVID and the engine push-out. I was wondering if you could just update us on the 2020 expected impact of COVID to revenue and EBITDA.

Jim Reagan (CFO)

We haven't provided anything specific. I can tell you that the change in the expectation on COVID-19 in 2020 is the revenue impact is going to be a little bigger, but it isn't materially bigger, and that the operating income impact on COVID-19 for the full year is a little bit lower, because of the recovery that we've seen in Q3 being a little bit faster than we had expected when we talked to you a quarter ago.

Gavin Parsons (Analyst)

Sorry, just to clarify, you're saying the revenue headwind is larger than you'd been anticipating last quarter for all of this year?

Jim Reagan (CFO)

A little bit. No, I wouldn't call it material. It's a small number.

Gavin Parsons (Analyst)

Got it. Okay. Roger, the comment on visibility into growth is really helpful just on, you know, the authority and outlays catching up to authority and the unobligated balance and your visibility in the backlog. If I look at, you know, just kind of the main investor day and the anticipation of a 5% addressable growth CAGR for your addressable markets, you know, how do you think about, you know, planning differently given, you know, the political uncertainty, the budget deficit, and then, you know, whether or not you're still in a growth posture for a five-year outlook and whether or not that changes how you plan for the business? Thanks.

Roger Krone (CEO)

Yeah. Okay. I'll try to be short because I know we're running late. First of all, you know, you raised the unobligated balance. By our numbers, it's $130 billion. There is a ton of budget overhang, if you will, unspent prior authorized balances. You know, add that to the CR, and you see your way through 2021 and 2022. Clearly, you know, in our investor day, we were talking 5%. We're kind of, our conversation now begins at 10% and goes north from there. We run the same scenarios everybody else does. What is the federal deficit? You know, what's it take to get to a balanced budget? Those numbers are in such large magnitude, I mean, you could remove the NASA budget completely, and you don't even make a dent.

We have some longer structural things as a country that we need to better understand, and there's some inflation that has to happen as you can pay debt off 10 years with inflated dollars and things. What we have heard talking to both administrations and the Hill is, we need economic growth. That's what's going to get us back on firm footing. You can't make huge reductions in federal spending and get the economic recovery that you need over the next, you know, three to five years. We may see a little bit of top-line temperament. I think the big change that we're going to see is, you know, if Biden were to get elected versus Trump, a reprioritization of what is a federal government budget that grows kind of with GNP.

You're talking 2.7% to 2.8%, maybe 3% GNP growth. If you plot history, president to president, the federal government spending is pretty constant. What changes is priorities within the two administrations or within different administrations. You know, we think we've done a really good job of portfolioing this company so that we can shift to more health and infrastructure, if a Biden government were to go in that direction. We've talked a lot, and I don't want to go on too much, but I don't think you solve the deficit problem with spending. I think you're going to have to find sources of revenue.

Everybody says, "Oh, well, that means taxes." We said, "Yeah, probably eventually we could see the corporate rate start to creep back to where it was." Other sources of revenue, like users' fees at parks and things like that, it's just what's going to have to happen. You know, you know, there's, you know, it's going to take some smarter people than I to figure out how we pay off these trillions and trillions of dollars that we've borrowed to keep people employed. With that, I think we, again, we got to wrap it up, but we can follow up with you on the one-on-one.

Gavin Parsons (Analyst)

Thanks.

Operator (participant)

Thank you. At this time, I'll turn the floor back to management for closing comments.

Roger Krone (CEO)

Okay. Thanks, 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.