Leidos Holdings, Inc.

Greetings, and welcome to Leidos' fourth quarter 2019 earnings results. At this time, all participants will be 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. As a reminder, this conference is being recorded. At this time, I'd turn the call over to Kelly Hernandez with Investor Relations. Please go ahead, Ms. Hernandez.

Thank you, Rob. And good morning, everyone. I'd like to welcome you to our fourth quarter 2019 earnings conference call. Joining me today are Roger Krohn, 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 January 3rd, 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 supplementary financial information, are provided on the investor relations section of our website at ir.leidos.com. With that, I'll turn the call over to Roger Krohn.

Thank you, Kelly, and thank you all for joining us this morning for our fourth quarter and full year 2019 earnings conference call. We delivered strong fourth quarter results, including record organic revenue growth, increasing margins, and significant year-over-year non-gap earnings growth. Our growth and execution momentum accelerated throughout 2019 and has continued into 2020 with significant new program wins and the opportunity to create value from our two recently announced acquisitions. I am confident that we are growing the company with the right talent, the right capabilities, and the right strategy to continue to drive value for our customers, employees, and shareholders. Revenues for the quarter were $2.95 billion, up 11.6% from the prior year and 14% organically, reflecting broad-based strength with all of our segments growing double digits. Our top-line growth was accompanied by an increase in our adjusted EBITDA margins, which grew to 11% in the quarter, up 2%. 130 basis points compared to the prior year period. Together, these drove our non-GAAP EPS to $1.51 for the quarter. For the full year, we generated revenues of $11.1 billion, up 11% organically, and we expanded margins to 10.5% while growing non-GAAP earnings per share 18% to $5.17. Growing revenues while also increasing margins and thoughtfully deploying our cash enabled Leidos to achieve total shareholder return of 89% in 2019, which was the highest among our peers. Jim will go through more detail on the results in a moment, But I would like to take this time to acknowledge our talented employees who enabled these significant financial successes through their operational execution. Their commitment to our customers and to our strategy was instrumental in our success and is what makes Leidos, the great company we are today, a great place to work. And I want to thank all of them for their hard work during the year. With regard to organic growth and operations, we have achieved significant success over the last few months. We won our two largest re-competes, GSM02 and Hanford, as well as our largest takeaway program to date in the award of the Navy Next Gen Program, which carries a ceiling value of $7.7 billion. These wins truly demonstrate the power of the scale of the organization we have built, as well as the breadth of our innovative capabilities. GSM02 and NextGen are both incredibly complex digital transformation programs for two of our nation's most important networks, the DoD and the Navy, respectively. We are proud to have been entrusted with this responsibility and are confident we will provide the DoD, our sailors, and Marines around the world with the tools they need to gain a warfighting edge in the modern digital landscape. Combined, these programs alone, Hanford, GSM02, and NextGen, have provided us with more than $18 billion in single award IDIQ ceiling value and eight to ten years of visibility, further strengthening our business. While two of these programs have been protested, we expect those protests to be resolved in the second quarter. We have a good track record on winning defensive protests, and if we are able to extend that track record and successfully defend these wins, work would begin by the start of the third quarter. Due to the protests and the IDIQ structure, these wins have not benefited our bookings at all yet. That said, beyond these notable wins, our business development engine continues to extend its period of strong performance with $3 billion of net bookings in the fourth quarter, bringing the total full-year net bookings to 14.5 billion. We exited the year with more than 24 billion of total backlog, a record level, and more than twice our annualized revenue run rate. Beyond our organic operational execution, we have also been successful on the M&A front. In the recent months, we entered into agreements for two acquisitions that will help us to accelerate the execution of our strategy. First was Dianetics, which we announced in December and closed at the end of January. And the second was L3Harris' security detection and automation business, which we announced in early February. This builds on our acquisition of IMX in 2019, which is now part of our healthcare business. We have disciplined acquisition criteria that we've talked about before and we're pleased to acquire these strategically important properties that fit well within the company and were acquired at prices that made sense. These acquisitions help to broaden our portfolio of products and services in high growth, high margin areas, further expanding the scale of the business. We believe these transactions will position the company on a higher growth curve and yield significant positive value for our customers and shareholders over the long term. I am proud of all those at the company who collectively helped to drive successful agreements for all of these acquisitions. This momentum in both organic and inorganic growth is due to calculated strategic initiatives we have undertaken throughout the organization. Throughout 2019, we elevated our business development organization and processes to successfully leverage the scale of the organization and the innovation embodied in our technical capabilities, allowing us to repeatedly and efficiently write successful proposals and win new contracts. We deepened our collaboration and partnership with our customers by engaging them early and providing them with innovative solutions to solve their mission challenges. We invested in our people through improved benefits, more training and development opportunities, and increased flexibility which enabled us to beat our hiring targets and cultivate a deep bench of highly talented leaders to advance our organization. As a company We have rallied around driving growth without sacrificing margin, converting profits to cash, and then thoughtfully deploying that capital in a balanced manner to drive shareholder value. To that end, we deployed nearly a billion dollars of capital in 2019, roughly 70% of which was returned to shareholders through share repurchases and dividends with about 10% used for M&A and the remainder for CapEx and mandatory debt payments. This balanced approach is consistent with the capital allocation plan we laid out at our May investor day. Also in accordance with what we have said in the past, with our net leverage ratio estimated to be at about 3.7 times post-closing of the security detection and automation transaction, we will pivot our capital deployment initiatives to focus on debt reduction until this net leverage ratio again approaches our target level of 3.0. We anticipate reaching that level in the first quarter of 2021. As we look to 2020, we are focused on successfully executing all of the opportunities we have captured in 2019. From an organic perspective, we have significant wins in each of our businesses that we are committed to executing well. While some are re-competes, all of them will require us to continue to bring innovation to our customers and a fresh perspective focused on effectively and securely delivering their missions. On the takeaway work, we're focused on starting off on a great foundation, ramping our recruiting efforts to ensure we have the talent to commit to the contracts and successfully executing those programs to deliver on all of our commitments. With respect to our inorganic initiatives, there are two sets of activities underway. First on the Dynetics acquisition, We are pleased to welcome the 2,300 employees from Dynetics to the Leidos family. Dave King, the CEO of Dynetics, will continue to lead the business, which is now the fifth business group within the company. The Dynetics business will be consolidated into our defense solutions segment for external reporting purposes. Dave will serve as group president and has been appointed as the newest member of the Executive Leadership Team. Additionally, we have appointed a leader for the Integration Management Office, or IMO, for this transaction who will be supported by representatives from each of the functional areas. This cross-functional team will ensure that Leidos business processes are followed and that Dynetics business systems are properly connected with the Leidos corporate systems, leveraging the strengths of both businesses in these efforts. Our integration activities will largely focus on knowledge sharing between Dynetics and Leidos in order to support new opportunity development. Second, regarding the recently announced pending acquisition of L3Harris' security detection and automation businesses, Once the acquisition has closed, these businesses will be combined with our existing security products business, which resides within our civil group. We anticipate the integration activities for this transaction will be more extensive than those of either Dynetics or IMX. However, they will be significantly less than our prior IS and GS transaction. where we demonstrated our ability to integrate successfully. We have already identified a preliminary set of activities and key leaders that would drive the cost and revenue efficiencies we previously discussed as being a key aspect of the transaction. We have a great playbook from the IS and GS transaction, the Leidos Business Framework, that will drive the actions and activities needed to fully integrate the business. From a macro perspective, we see 2020 as an extension of the strength we saw in 2019. Outlays are projected to continue to rise at least through fiscal year 2022, given the large prior year unobligated balances. DoD's investment accounts, procurement and R&D, continue at historically high levels. The top technology priorities are consistent with last year's, with strong emphasis on space, hypersonics, cyber, and electronic warfare, and are directly aligned with our growth initiatives and technical capabilities. The President's Physical Year 21 budget request was released last week. The request sets discretionary spending levels at $741 billion, including overseas contingent operations, for defense roughly flat with the prior year. Our initial review of the available material shows budget increases directly aligned to our areas of strength, cyber, artificial intelligence, hypersonics, and space. The budget request of $590 billion for non-defense represents about a 10% decline from the prior year. While the agencies we have exposure to are far less impacted by the proposed cuts, the Democratic-led House is unlikely to accept significant decline in the non-defense agencies. We expect negotiations on agency-level appropriations to take place over the next few months and likely conclude by the summer. Overall, we are encouraged by the visibility and priorities defined by the budgets and expect to benefit from that at least through the next couple years. With that, I'll turn the call over to Jim Reagan, our Chief Financial Officer, for more details on our results in our 2020 outlook.

Thank you, Roger, and thanks to everyone for joining us on the call today. Leidos achieved record results in 2019, and this strong momentum has continued so far into the first couple of months of 2020, starting first with revenue. We achieved 14% organic growth in the fourth quarter, which was driven broadly by the ramp-up of new program wins in all of our businesses. In addition to this, during the quarter, we benefited from the impact of a couple of extra working days driven by the effect of the 53-week year. The 11% adjusted EBITDA margins in the quarter, a record for the company, reflect a few key items I want to note. First, the primary driver is our strong program execution. This is one of those items that doesn't typically get a lot of attention, but across the company, our employees' commitment to our customers and to the missions we help them perform is at the heart of our strong program performance. Consistency in delivering on our commitments, and in many cases going above and beyond to ensure our customers are successful, is recognized and rewarded by our customers both through award fees but also through new program awards that we believe will help continue this momentum. Second, as we've alluded to on prior calls, as new program wins mature, margin increases. Throughout the year, many of the new programs that had impacted margins earlier in the year continued to mature, enabling us to improve margins in the fourth quarter to the highest margin level during the year and, as I said, in the company's history. Non-GAAP diluted earnings per share of $1.51 in the quarter drove the full-year non-GAAP earnings to $5.17, exceeding the top end of our guidance range. Fourth quarter non-GAAP EPS grew 37% from the prior period, reflecting the revenue growth and increased margins, as well as a reduction in share count of 6 million shares, resulting from our share repurchase activity during the year, including $25 million in the fourth quarter. Cash flow from operations in the quarter was $169 million, driving our full year number to $992 million, again considerably above our guidance. After adjusting for capex of $121 million in the year, we converted 116% of our non-GAAP net income to free cash flow. As we've said in the past, our target here is 100%, and occasionally we will over or underperform relative to that, primarily driven by the timing of advance payments. In 2019, As we've mentioned on prior calls, we benefited from approximately $100 million of advance payments from customers. We expect these to reverse in 2020, and we will talk more about them when we get to guidance. Business development results for the quarter and the year were also very strong. At the consolidated level, we exited the year with a record backlog level of $24.1 billion and a trailing 12-month book-to-bill of 1.3%. All of our segments generated book-to-bills for the year north of 1.0, with health being the strongest at 1.6x. As Roger indicated, these results do not reflect the recent wins that are under protest. Now, let me share some comments on our segment results. Revenues in the defense solution segment accelerated throughout the year, exiting at a 10.7% growth rate in the fourth quarter compared to the prior year. This growth and acceleration primarily reflects the ramp of new takeaway programs, such as ACCISR, and a great job of driving on-contract growth on GSMO and several other classified programs. The business also benefited a bit from seasonally higher materials purchases in the fourth quarter. Non-GAAP operating margins in our defense solutions segment increased to 9.9%. up 220 basis points from the prior year quarter and 190 basis points sequentially. The increase was driven by program write-ups that reflect strong program performance, as I indicated earlier. The margins also reflect an approximate 70 basis point benefit from a reserve release that was associated with the successful settlement of an outstanding legal matter. As we look to 2020, similar to what we saw in our civil segment in late 18 and early 19, the large volume of expected new program ramps, including GSM02 and Navy Next Gen, is likely to dampen margins in this segment temporarily. In our civil segment, revenues in the fourth quarter grew 16.2% over the prior year. This reflects the continued ramp of program wins from late 2018 and beyond, including NASA NEST, DOE NETL, and the FAA Future Flight Service Program, or FFSP, and a high level of security product shipments. We also benefited from higher volumes in our Hanford and Antarctic support programs, reflecting typical seasonality. Volumes in these programs are more weighted in the second half of the year, and we expect the same pattern in 2020. Civil segment non-gap operating margins of 11.4% in the quarter reflect a significant nearly 400 basis point improvement sequentially and a 160 basis point improvement over the prior year. As you may recall from the third quarter, margins reflected a write-down on some receivables on an overseas program and that we anticipated a recovery to more normal programs that we now see in the fourth quarter. The fourth quarter is also when the majority of our gain share is recognized on our LCST program in the UK and this drove an incremental benefit in the quarter as well. Turning now to our health segment, fourth quarter results were strong here across all metrics. Revenue grew nearly 14% organically, adjusting for the divestiture of the commercial health business, which closed in the third quarter. Revenue growth was driven by higher volumes in our disability exam business, the ramp-up of a recent award with CMS for End User Centric IT Support, or ECIS, as well as the continued ramp of DIMSOM deployment activity. Non-GAAP operating margins remained well north of our target at 16%, driven by strong operational performance across the segment, including increased contributions from one of our more nascent businesses, Digital Health Solutions, where we're having increased success selling the broader company's suite of digital transformation capabilities into the commercial health market. We continue to expect normalized margins in this business in the low to mid-teens, and as we've said, there will be some quarters that deviate from that, driven by program mix and volume. Overall, 2019 was a great year, not just for the operational and financial successes that our team has delivered, but for the $14.5 billion of net new bookings and more than $18 billion of new single award IDIQ ceiling awarded to the company. These successes, as well as the M&A transactions that we've highlighted, will position us for continued growth and success in 2020 and beyond. Now, on to our guidance for 2020. We recognize that there are a lot of moving parts between the acquisitions and the recent large program wins, so we will try to be a little bit more descriptive in our commentary. First, we expect revenue in the range of $12.6 billion to $13.0 billion, reflecting growth of 13% to 17% from the prior year. And we've included approximately $900 million of Dynetics revenue And in this guidance range for the prior year, in line with our prior expectation, what we've prorated it for the effective closing date of January 31st. We've also embedded an expectation that our run rate on Hanford and GSMO will continue at their historic run rates, despite these awards being in protest. We've included a minimal level of contribution from NGEN, allowing for some potential downside risk, reflecting the potential for future protests. We expect adjusted EBITDA margins of 10.0 to 10.2% for the year. After adjusting for the $54 million benefit realized in 2019 from the payment from the Greek government, this reflects up to 20 basis points of improvement in 2020. We expect non-GAAP EPS between $5.30 and $5.65 on the basis of 144 million shares outstanding flat with fourth quarter levels. As we've indicated, we're pivoting our capital deployment initiatives to debt reduction rather than share repurchase until we get our target net leverage ratio close to 3.0x. Our non-GAAP EPS guidance includes approximately 20 cents of accretion from our Dynetics acquisition. We expect operating cash flow of at least $1 billion. This includes a minor contribution from the Dynetics acquisition as the earnings benefit in the first year will be partially offset by transaction and integration costs. These costs, which we disclosed previously, are expected to be approximately $40 million in 2020. As I indicated earlier, operating cash flow for 2020 reflects the impact of an approximately $100 million reversal of advance payments received in 2019. We've also implemented an accounts receivable monetization program for approximately 200 million of our receivables. This further progresses our balance sheet optimization goals. We remain committed to operating with a lean balance sheet and, where appropriate, monetizing underperforming assets. Now, a couple of other comments to help you with modeling 2020. We expect interest expense of approximately $170 million, excluding transaction-related expenses. We are also expecting a slightly higher non-GAAP tax rate in 2020 of 23%. We expect to incur $170 million of capital expenditures in 2020. Now, this includes $30 million of real estate-related investment associated with the build-out of our new headquarters and other real estate optimization activities. This is the last year where we expect material real estate-related investment. Our normalized go-forward run rate for CapEx should be about 1.0% of revenue, including the impact from the Dynetics business. To wrap up, we exited the year with strong momentum and tailwinds and a group of 36,000 employees committed to delivering innovative solutions to our customers, driving value for our shareholders, and executing on our commitments. And with that, I'll turn the call over to Rob to take some questions.

Thank you. At this time, we'll be conducting the question and answer session. If you'd like to ask a question today, please press star 1 from your telephone keypad and a confirmation tone to indicate your line is in the question queue. You may press star 2 to remove yourself from the queue. For participants using speaker equipment, we ask you please pick up the handset before pressing the star keys. Thank you, and our first question is from the line of Matt Akers with Barclays. Please proceed with your question.

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

Yeah, hey, good morning.

Hi, Matt. Thanks for the color on margins and some of the program mix between mature and new stuff. I guess you talked about how you sort of think of the long-term. You talked about the 10% plus deep and down margin. Is that the right way to think of it, or these new acquisitions are a little bit accretive? Could that potentially be a little bit higher?

Well, Matt, thanks for the question. I think that this year, particularly as we close out 2019, we're seeing the benefit of strong program performance, and that's put some nice upward pressure on margins. And clearly, the two businesses that we've acquired or are in the process of acquiring in the case of the security products and automation businesses, they will also be accretive to our margin profile. So I think that over time, as we combine the strong operational execution, getting some revenue and operating synergies out of the acquired businesses, I think that you're going to see us moving the margin expectation upward.

Got it. Makes sense. And then I guess, could you touch on kind of the long-term cash flow operation guidance? You've talked about the $2.7 billion 2019 to 21. I think you're You're already at about $2 billion through 2020. What's the right way to think about that going forward?

Well, you know, that three-year horizon that we talked about before, we certainly are pleased with our progress on that. I think that, you know, because of the advance payment that we mentioned that will be reversing in 2020, that's a bit of a short-term cash flow headwind. That's going to be offset by the fact that we're monetizing about $200 million of our receivables with a very low-cost facility that will allow us to show some offsetting uplift in operating cash flow for the year.

Got it. Thanks.

Our next question comes from the line of Sheila Kayagu with Jefferies. Please receive your questions.

Good morning. This is actually Ellen on for Sheila. Thank you for taking the question. So with contracts such as GSMO and Navy Next Gen, which point to your cloud capability, is there any way to frame what the advantages are in this market and any other opportunities there are to deploy this capability for the Army, Air Force, or other customers?

Yeah. Hey, Ellen, and thanks for joining us. I think our position in that digital landscape is close to the customer and helping the customer utilize the capabilities of the cloud and digital transformation, things like software-defined networks and virtualization. And, you know, there is opportunity to bring those digital transformation capabilities to other customers, the Army, Air Force, frankly some of the other federal agencies as well. And as we've said before, you know, we're really cloud provider agnostic. and we're that value-added layer that allows our customers to really modernize and drive efficiency into their day-to-day operations. And so it's been a great growth market for us, and we see it rolling into our healthcare business, our commercial energy business, and it's been part of our growth engine.

Great. Thanks for the question.

Our next question is from the line of Kai Von Rumer with Cowan & Company. Pleased to see you with your question.

Yes, thanks so much and good quarter. So if we look at the margins, you mentioned, you know, lower initial margins on NextGen and GSM-O. Two questions. One, when do you expect the, I mean, do you still expect those to reach the corporate average, you know, in a couple of years as they mature? And secondly, given those will be below average margins, are there any other areas – well, what are the other areas that maybe are a little bit stronger to get you home to the 10% plus adjusted EBITDA total? Thanks.

Kai, thanks for the question. You know, when we think of how we want – how we manage the business in Internally, we manage the thousands of contracts and programs that we have as a portfolio, and we bid things like Navy Next Gen, GSMO, with a view that as we begin the process of innovating for a new contract, we're going to make those investments with a view that they would get at or above the company average as they continue to mature beyond the first or second year of the program. If you think about, and I'll just give you some examples, the margin on a program like NASA NESS, which was a takeaway win for us last year, that is already beginning to move upward from that early phase of where we're investing. And so the larger programs like that typically do have lower margins early on, and Some of the reserve releases that we've talked about, some of the write-ups that we've had in the fourth quarter are, in fact, from programs that are maturing and give us the capability to tick up on the profit recognition ratios we have there. And, again, it's a function of a lot of programs, and I gave you one example in NASA of where the margins escalate over time.

Thank you.

Thank you. Our next question is coming from the line of Edward Caso with Wells Fargo. Please proceed with your questions.

Good morning. Congrats on the numbers here. Curious that you seem, Roger, you seem more positive on the budget process this year, if I heard right. Is there some reason for that, particularly as we go into an election year? And also, if you could talk about your expectation for any cyclical activity and award announcements plus or minus the election. Thank you.

Yeah. Hey, thanks, Ed, and thanks for joining us. We've looked back at history and the end of a first term in the White House, and there is a reason to kind of get the cycle in the fall. And, you know, as we are up on the Hill and talking to authorizers and appropriators, certainly at the staff level, they are working hard to get the rest of the budgets complete. I think the president has now set the top level. There seems to be broad agreement at the top level. And now the staffs have to do the work to get the budgets done. And I just don't see a lot of appetite for having the budget process roll through the election season. By the way, there are other people who think we'll be in a CR through the end of the year, but I'm more optimistic than that. We do know that we're in what I think is the 130th month of economic expansion in the United States. I think the largest period of expansion since the Great Depression. And I think all of us in business look at that with a careful eye and thinking, okay, what could be out in front of us? We look at the coronavirus. We keep an eye on interest rates. But the economy is running well, and we continue to see economic growth. But I think we're all being thoughtful, and that's why Clearly, at Leidos, we are more conservative in our balance sheet, and we like to stay away from the high leverage. That way, if we were to see interest rates increase, we would be protected and insulated against that.

Thank you.

Thank you. Our next question is from the line of Toby Summer with SunTrust. Please receive your questions.

Thank you. As you look at managing the business beyond just the kind of current horizon and maybe think about several years from now, what are the risks associated with higher margin future acquisitions if margins continue to march higher from this relatively high place here in the fourth quarter over the next two or three years?

Toby, it's an interesting question. I think that the if I understand your question right, it's what is the risk that there could be some interruption in what we view as an environment where we have opportunity to gradually increase margin. And I think that for us it is more an issue of continued execution. And by continuing to execute well on the existing programs that we have, and combine that with realizing the opportunity from the acquisitions that we're making where we think that there is some margin expansion opportunity that's accretive to the overall company. I think that we simply have to execute on the acquisitions that we've made consistent with the playbook that we used when we acquired the IS and GS business and drove 200 basis points of margin expansion out of that. Now, I don't want to make it sound like we're setting the bar for that on the deals that we're doing now, but we certainly believe that there's some opportunity that we can execute on there.

Yeah, hey, Toby, I would add to that. Because of our success and how we've grown, there may be people who feel like we have to bid on a broad array of programs, even if they don't meet our expectations for return. And I would I would simply point out is that even at the size we are today, we have the opportunity to pick and choose what we go after. And as we have said in prior calls, we're being really thoughtful about which businesses we bid on. And if we don't see the potential for kind of our corporate average return on a program, we have the strength and the will to not bid those programs and And therefore, we feel pretty confident that we can maintain the margins at the current level and then maybe hopefully improve those with some performance.

Thank you. Our next question is from the line of Seth Simon with JPMorgan. Please proceed with your question.

Thanks very much. Good morning and good quarter. Just looking at the guidance midpoint on the organic side, it looks like maybe it's kind of six to seven-ish in terms of what's baked in there. If you could give us a little help, maybe not the exact guidance, but just kind of slotting the segments relative to that midpoint and talking about what might be the potential areas for upside if you were to outperform.

Yes, Seth, this is Jim Reagan. I think that, first of all, as you know, we don't issue guidance by segment, but to your first question, you can think about the organic growth implied by our guidance range being about 7%, and that we feel good about the growth that we've experienced across all the segments of our business in 2019. And because we've had book to bills north of 1.0 for all of our segments, all of our businesses, we remain confident that we'll have strong growth across all of our business segments in 2020.

Great. Thanks. And then I guess when you look at the award opportunities in 2020, I guess what stands out to you as kind of the major opportunities coming up for this year?

Well, you know, the lion's share of the growth that we're expecting to experience in 2020 is going to be on the recent program wins. And particularly, you know, in the back end of the year, we've indicated there's going to be the beginning of the ramp-up of the NGEN program. And the on-contract growth that we've experienced in 2019, which was a significant part of our ability to grow the business in addition to, you know, wins from 2018, you know, things like NASA Nest or the Army Corps of Engineers IT Modernization Program. We've had strong growth in health off of the digital health solutions business. Those are the kinds of programs that we think are going to continue to be growth drivers into 2020. Great.

Thank you very much.

Our next question is from the line of Joe Donardi with Stifel. Pleased to see you with your questions.

Hey, guys. This is John on for Joe. I guess the first question I have is around Dim Sun. Can you kind of update us on its contribution to organic growth in the quarter and your expectations for the program going into 2022 – excuse me, 2020?

You know, again, detailed program performance and growth rates by quarter, we're not accustomed to giving out. But, look, I think it's fair to say that you can think of the growth rate that we've experienced in 2019. About one point of that has been because of the uptick in revenues on our dim sum program for the Defense Health Agency program. The growth rate there in the coming year is going to be not quite as strong, but still the program is continuing on an upward trajectory.

Yeah, I would just add, you know, we're now to the point on the program where we're essentially have four waves in process. So, you know, we're starting one and completing one. You know, today we're going from, you know, wave Travis all the way to the Coast Guard pilot and So we expect to keep that pace now for a considerable period of time while we roll out the program and put the new electronic health care record system at all of the DHA installations.

Thanks, guys. You also talked a lot about scale and the advantages of scale for Leidos, especially with some of these new wins. Can you just kind of touch on what exactly is the scale advantage that you're enjoying today and why it's different today versus in the past, say, when you look at old SAIC. What are you guys doing differently now that couldn't be done or wasn't being done back then?

We've always talked about scale in a couple buckets. We're still very people-oriented, very much a people company, and our size and scale allows us to recruit at more colleges, to have more job fairs, to spread more broadly, and that is really, really important. And attracting people at college level, mid-level, and at the senior levels has really allowed us to fuel our growth. The scale, and we talked about this is a major reason why we did the Lockheed deal three and a half years ago, is it brought a whole set of new customers, which broadened and diversified our portfolio. And we see that happen again and again every time we do some, we win a new program or we have the inorganic growth. We're thrilled with the broadening of our technical differentiation and the capabilities that we have and what scale allows us to do is to spend our internal R&D money to invest and differentiate those capabilities. And then something kind of unique to the government contracting business that maybe commercial customers don't quite understand, but to bid on opportunities in our space, you need to have what we call past performance qualifications, which means you need to have already done that kind of work either for the same customer or for a similar customer. And if you don't have that in your portfolio, oftentimes you're not even allowed to submit a proposal. And with our broader portfolio, we have past performance quals and something called IDIQ contract vehicles, which is a nuance in our industry I won't go into. But we have a lot more of the qualifications that allow us to participate in these broader markets and We've seen since the IS and GS acquisition that all of these have contributed to our top line growth.

Our next question is from the line of Gavin Parsons with Goldman Sachs. Pleased to see you with your questions.

Hey, thanks. Good morning. Hi, Gavin. Hi, Gavin. You know, given you come off 10% organic last year, I think you said seven next year. Obviously, you've de-risked with a lot of re-compete wins. You've got some takeaways. You've got these acquisitions that should be accretive to organic growth. You know, it wasn't too long ago that you kind of got at a 5% organic CAGR going forward on the 2019 to 21. So just curious if you have any updated thoughts there. What's led to such strong outperformance just at 19 alone and just anything going forward there?

Yeah, well, there's a couple of things, Gavin. One of them is we've done a great job this year of hiring, and when we were setting our guidance out a year ago, we were thinking of the ability to hire as being a governor, and we've made that a new core competency of the business. The second is on-contract growth. We've done a lot to train our teams to to help customers by selling into existing vehicles, help them broaden the kind of mission areas that we address. And then the other thing is that we have a couple of businesses and really a couple of large contracts that are winding down in the coming year, which are going to be a bit of a headwind in the backdrop of some really strong business development performance in acquiring new and takeaway wins this year. So I think that it's fair to say that at a midpoint of seven organic growth, we're being pretty careful in how we measure our ability to continue that string of success and ramp up the new program wins really fast.

That's helpful, Collar. And then maybe just trying to scale from a bit of a different angle. I mean, are you seeing the customer structurally shift to larger contracts, whether it be put more in kind of, say, GSA or large IDIQs? Is that a structural shift that you stand to benefit from?

Yeah, Gavin, you know, I think we see that in some customers, and then we see other customers who take a large program like the old NMCI program In the Navy, they actually broke that contract into a hardware and a software services and architecture program in the Navy. So, you know, we won the – it's called SMITY NGEN program, which is the non-hardware port part of the old NMCI. And, you know, another contractor won the hardware. And, you know, I think each agency – looks at their portfolio, and although I think there is a tendency to aggregate, there also will be times when they say, okay, maybe we've reached a level of scale and we want to have more players and they just aggregate. So I think in the life cycle we see both and not necessarily a trend one way or the other. What you do see in the way we behave, because of what we've done with the company, we tend to look for larger opportunities. And it's interesting, it almost costs as much money to write, you know, say a $250 million proposal as it does to write a billion dollar proposal. And if we can take the same resources and pursue larger opportunities, we can be more efficient in the dollars that we spend. We call it our new business fund spend. And So we have been doing that over the last couple years.

Got it. And then just quickly offhand, do you have your 2020 or 2021 recompete rate?

Thank you. We don't issue or we don't disclose the recompete win rates, or for that matter, for new business or takeaways. What we have said in the past, and it continues to be true, is that our win rates on the All those categories are above 50%. This year, the re-competes are going to contribute about 20% of our – the things that are being bid in the coming year will be responsible for about 20% of our overall revenue. Okay. Thank you. Sure.

The next question comes from the line of John Raviv with Citi. Please proceed with your question.

Hey, guys. It's Colin Canfield on for John. Appreciate you taking the question. Just going back to the comments before about new programs versus segment average margin, can you just discuss a little bit the assumptions that you guys have with respect to the geography of labor and how you guys are able to offset some of the costs of that by distributing the labor to kind of non-core areas?

Let's see, I think you asked, let me answer the question I want to answer, but although we have a customer concentration in the national capital region and there are some contracts that require us to perform work within a certain geographical radius of those customers, we have had success in moving work outside of these sort of dense economic areas to places where the job market is better And we have been doing that over the past couple years, and we continue to do that in 19 and in 20. And we have built new facilities. We call them Centers of Excellence in Software Development. We kind of refer to them as software factories. But, you know, open, planned, new buildings in places around the country, near major research colleges and universities everywhere. that have outstanding computer science programs. We have enjoyed success in capturing students and graduate students and allowing them to participate in our secure DevOps process and our agile software development. I think that has been really, really successful for us. We have seen some signs open up down the street with some of our competitors' names on them, so I think it is a trend that we're seeing within the government contracting space.

Got it. Thank you for the color. And then in terms of the larger contracts, right, where you guys are doing both software and hardware, can you just talk a little bit about, you know, say, for example, NGIN, right, and getting to the company average margin by year two? Can you just talk a little bit about the, like, risks with regards to hardware implementation that might affect that comment? Yeah.

Well, in the Navy Next Gen, they actually split the contract into two pieces. There's a hardware contract, which we didn't participate in. I think it was won by HP. And they will provide the hardware. And unlike our NASA NEST program, where we did both and we actually brought the hardware anyway to buy some existing hardware and do a technology refresh, On the Navy Next Gen program, we don't have that hardware component in our contract. Ours is around architecture and transforming the network. And so there's really no pass-through. There's really no hardware implementation risk. And oftentimes in government contracting, if you're simply passing through hardware, sometimes you're not allowed to put fee on that. Sometimes the fee rate is less. And That is not the case on our Navy Next Gen contract.

Got it.

Thanks for confirming that. Appreciate the call.

Thank you. At this time, I'll turn the floor back to Kelly Hernandez for closing remarks.

Thank you, Rob. Thank you all for your time this morning and for your interest in Leidos. We look forward to updating you again soon. Have a great day.

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