Perspecta Inc.
Q2 2019 Earnings Call Transcript

Published: 15 Nov 2018

[Operator:]

Good afternoon and welcome to the Perspecta Second Quarter Fiscal Year 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Stuart Davis, Vice President of Investor Relations and Strategy. Please go ahead.

[Stuart Davis:]

Thank you, welcome everyone to today's quarterly earnings conference call, our second as a public company. Mac Curtis, our CEO; and John Kavanaugh, our CFO are here to discuss our financial results, business momentum and forward-outlook. Today's call is being webcast on the investor relations portion of our website, where you'll also find the earnings release and financial presentation slides that we will use for today's call. Turning to Slide 2 of the presentation, please note that during this call we will make forward-looking statements that are subject to known and unknown risks and uncertainties that can cause actual results to differ materially from anticipated results. For a full discussion of these risk and uncertainties please refer to our SEC filings including our Form 10-K for fiscal 2018. In addition the statements represent our views as of today and subsequent events may cause our views to change. Though we may elect to update the forward-looking statements at some point in the future we specifically disclaim any obligation to do so. Finally as shown on Slide 3, we will discuss some non-GAAP financial measures that we believe provide useful information for investors. The slide deck for today's call includes reconciliations to the most closely comparable GAAP measures. At this time, it's my pleasure to turn the call over to Mac, who will begin on Slide 4.

[Mac Curtis:]

Thank you, Stuart. Thank you all for joining us on this afternoon's call. On behalf of the entire Perspecta team. I'm pleased to report that our second quarter showed strong operational performance across the board. Like I did in the Q1 earnings call, I'll focus on a few key messages. Now recently John and I spent some time on the road with investors and the meetings confirmed that these four messages are of keen interest to the investment community. First, our financial results from the second quarter demonstrate that our financial model is intact and leading towards the upper-end of our previous guidance. Second, integration has been a major focus and we're on plan. Third NGEN recompete is on track. We've signed two sole source extensions and we look forward to winning the new contract and forth. We're already seeing revenue synergies from the merger as our innovation engine in patent portfolio differentiate us in the market. Now, let me dig a little deeper on each of these messages. First, our financial performance is tracking well to our model. From top to bottom, our financial results again exceeded our expectations. Revenue was up 1% year-over-year and up 3% sequentially on a pro forma basis, with industry leading adjusted EBITDA margins of 16.5% adjusted EBITDA was up 9% and adjusted diluted EPS was up 2% year-over-year and again our collections were excellent with adjusted free cash flow of $105 million or 142% of adjusted net income. Bookings were strong as well with a book-to-bill ratio of 2.3 times and a healthy mix of new business. As a result of our strong performance through the first half of the year our positive outlook for the remainder of the year. We were upwardly revising fiscal year 2019 guidance for all metrics as John will describe a little later. Second, integration is proceeding well. We're making good progress on all fronts. We're about two quarters in and we're generally ahead of where we thought we'd be. Integration is hard work, but we've got a couple of key factors working in our favor. Number one, the value proposition makes sense to our customers and to our employees. And number two, we developed detailed integration plans for seven months prior to close that prepared us to execute. Our financial and business development results are indicators of success, but let me provide a little more color. The most important aspect of integration success is the people side, and we're making great progress. We're doing the heavy lifting necessary to create the culture and build the workforce that will define a unified perspective. We've established incentive programs including short-term, long-term and for business development that will reward great performance and create a compelling retention incentive for top performance. Overall, the incentive programs are selective, but are designed to reach more of our employee population as compared to similar programs for our peers. This is consistent with our outcome driven performance based culture. The programs had been well received by our people and should lead to better recruiting, retention, and more important results. Short term incentives will be delivered in cash based on performance against revenue and adjusted EBIT goals. Long-term incentives for the leadership team will be delivered primarily and performance stock units based on performance against three year adjusted diluted EPS and adjusted free cash flow goals. Our incentives are clearly aligned with shareholder interest. Later this month we'll have our first open enrollment that establishes competitive and comprehensive benefit plans that support talent retention and attraction and to meet cost objectives. This new benefit program marks another important step in making Perspecta a top talent destination. Results today on the talent front have been encouraging, head count is growing, and attrition is normalized. We ended the quarter with approximately 14,500 employees. Our culture, mission focus and core values, make Perspecta an attractive employer and expect to sustain positive employee trends over time. In other areas, we remain on track to realize the $43 million of cost synergies and $20 million of delivery savings cost in fiscal 2019 that we committed to as part of the integration planning. We're making good progress on rationalizing our real estate footprint and we're aggressively working plans to consolidate our back office systems. Now, third, NGEN is about where we said it would be going back to the May Investor Day. Since the August call, we've signed two sole source extensions that take us through May of 2020. Importantly, the funding across the contracts is relatively consistent with a current run rate, which means that we can continue to execute without interruption and our customers can continue to move in network and their mission forward. As we indicated at our Investor Day, the recompete or NGEN-R will grow in scope compared to NGEN and be split into two separate procurements, one for an End Used Hardware known as EUH and the other for Services Management Integration and Transport known as SMIT. Request for proposals are now out for both EUH and SMIT and proposals are currently due December 5, and January 10 respectively. Now we respect our competition on this program, but we're excited about the recompete, the move to best value will enable us to accelerate the modernization and transformation of the Navy and Marine Corps network and provide greater impact to our customers. I've spent much of the last several months meeting with our customers throughout the Navy and Marine Corps, and I'm convinced that they recognize the numerous contributions of our team over the last few decades. More importantly, they see the value of perspectives, rich IP, innovation portfolio, agility, advanced networking, security and cloud capability as they look towards the future. And fourth, the revenue synergies that we expect are beginning to show. Most obviously the strong bookings results for the quarter. Bookings totaled $2.4 billion in the second quarter, representing a book-to-bill ratio of $2.3 times. Year-to-date book-to-bill is 1.8 times. Of the second quarter bookings 643 million or 27% were for new business. As a result Perspecta’s backlog of signed business orders at the end of the second quarter of fiscal year 2019 was $10.2 billion, which was up 13% compared to the first quarter of fiscal 2019. Funded backlog at the end of the quarter was $2 billion, an increase of 1% sequentially. Largest award in the second quarter was a one-year $787 million NGEN extension. The additional eight-month extension will be a Q3 award. In addition, we had a major expansion on our applications and infrastructure support contract with a defense manpower data center, about 30% of the $564 million DMDC award will be for new work. On the last call I told you about the new technical support services indefinite delivery, indefinite quantity contract with U.S. postal service. Now, this quarter we're able to transition all of our existing work in this area over to that vehicle. We've also begun to win some new work in security and applications development and monetization. So, the forward outlook for bookings remained strong. We have a robust pipeline of $68 billion of qualified opportunities over three years, including $8 billion of proposals already submitted and awaiting a decision. The vast majority of our pipeline represents new business and growth opportunity for Perspecta. Now, one of the drivers of capturing this new work will be the innovation from Perspecta labs and that centrifuge keeps on spinning, especially in the area of cyber and network security. Two recent awards from the defense advanced research projects agency or DARPA illustrate the type of work we're doing. On the first in support of the configuration security or ConSec program we're developing technologies that automatically generate, deploy and enforce configurations of components and subsystems for use in multi-platforms. The configurations must deliver needed functionality and performance while addressing system vulnerabilities and minimizing attack surfaces. The technology has clear applicability to critical infrastructure and network connected systems for the Internet of things. On the second, we're supporting the cyber hunting scale or chase program. The goal of chase is to develop dynamic real time tools that can successfully defend large-scale distributed network from broad-spectrum cyber attacks. Perspecta labs will design and develop a set of components for threat detection and characterization that will accelerate the hunt process by translating a high-level threat description into possible concrete implementations using a variety of sophisticated analytic techniques including adversarial planning, genetic perturbation and data driven evaluation. In summary, our end markets are growing and innovation and intellectual property differentiates us from our competitors. Our entire team has worked hard to stand up a new company without missing a beat on delivering mission success for our customers. With each passing day, we were executing more efficiently, coming together more closely, and creating a stronger, more unified company that we can all be proud of. Now John will go through the financials in detail and provide our forward outlook.

[John Kavanaugh:]

Thanks, Mac, and good afternoon, everyone. I'm extremely pleased with our second quarter results. Our entire company across both business and functional groups has risen to the challenges of the market and the complexities of integration and performed at an exceptionally high level. We acted with urgency, discipline and purpose, which I believe are true hallmarks of Perspecta. Now I'll go through the key financial results and drivers beginning on Slide 5. In Q2, we had a full quarter of contribution from all three legacy companies. For sequential and year-over-year comparison periods, I'll refer to pro forma results, which assume the spinoff and mergers occurred at the beginning of fiscal year 2018. For current and past periods, I'll also exclude costs directly associated with either the spin merger transactions or the ongoing integration process. We believe these pro forma and adjusted results provide an important baseline for comparing performance across periods. Our press release and presentation slides provide the reconciliations from pro forma adjusted results to GAAP. Revenue for the quarter was $1.07 billion, up 1% from the second quarter of fiscal year 2018 and up 3% from the first quarter of fiscal year 2019. This growth was driven through our defense and intelligence segment, which increased 8% year-over-year, with strong performance in our intelligence community and federal background investigations support businesses. During the quarter, we successfully completed a large classified fixed price contract earlier than originally anticipated, which resulted in a $13 million revenue pull forward from Q3. Civilian and health care revenue decreased $40 million or 10% year-over-year. $38 million of the revenue decrease was due to the successful completion in December of 2017 of the large engineering support contract for the Kennedy Space Center. Q2 adjusted EBITDA was $177 million, which was up 9% compared to year-ago pro forma adjusted EBITDA as margin improved from 15.4% to 16.5%. Excluding the gain from the contract divestiture in Q1, adjusted EBITDA margin was steady quarter-over-quarter and right in the middle of our forecasted range of 16% to 17%. The strong adjusted EBITDA performance is a result of disciplined execution. We're on track to meet all of the commitments around merger cost synergies and operational efficiencies. We obsessed our cost tax. We lived within our cost envelopes and we're committed to being one of the most efficient government service providers. Contract mix is a primary driver of our industry-leading adjusted EBITDA margin. In the second quarter, our mix moved sharply towards an even richer blend of fixed-price work. As a percentage of total revenue, our contracts were 57% fixed-price, 20% time and materials, and 23% cost-plus. This quarter's mix was held slightly by the revenue pull forward on a fixed price program that I just mentioned. But we expect that over the long-term, contract mix will continue to move in the direction of fixed price. Depreciation and amortization totaled $74 million in Q2. Included in the D&A is $36 million of acquisition-related intangibles amortization, which is backed out of adjusted net income and adjusted diluted EPS. We also incurred $26 million of transaction, integration and restructuring expense, which is excluded from all adjusted metrics. Most of the $2 million of restructuring expense is reimbursed by the government. Interest expense totaled $37 million in Q2, which includes the interest on our term loans and capital leases. At the end of the quarter, about 60% of our debt was fixed. Since then, we have executed additional swaps to lower interest rate risk. Interest expense should be fairly steady for the remainder of the year for fiscal year 2019 total between $140 million and $145 million. To calculate adjusted earnings, we applied our expected long-term effective tax rate of 27%. This resulted in Q2 adjusted net income of $74 million or $0.45 per share against a diluted share count of 166 million. Adjusted diluted earnings per share for the quarter were up 2% year-over-year and also up 2% on a sequential basis, after controlling for Q1 divestiture gain. Adjusted diluted earnings per share were less than adjusted EBITDA, primarily because of the timing of capital lease conversions, phasing out of purchase price accounting and remapping of corporate assets as a stand-alone company. These factors increased depreciation and amortization, excluding acquisition-related intangibles amortization, by $21 million. Turning to Slide 6. During the second quarter, we generated $76 million of cash flow from operating activities and $105 million of adjusted free cash flow or 142% of adjusted net income. Looking at the quarter, the primary difference between the cash metrics was $46 million of capital expenditures, which includes capital lease payments. A relatively high capital intensity is consistent with our high mix of managed services enterprise IT delivery, and these assets can lead to higher adjusted EBITDA margins and stickiness with our customers. Working capital management performance was very strong across the board. Days sales outstanding for the quarter, excluding any benefits from the account receivables factoring program, were 55 days, a sequential improvement of two days. We're operating within our target DSO range of the mid to high 50s. As you recall, we were prohibited from repurchasing shares in Q1. This quarter, we were able to execute our balanced capital deployment plan with a mix of debt paydown, share repurchases and dividends. During the second quarter, we paid down $50 million in debt, returned $31 million to shareholders, $8 million in quarterly dividends and $23 million in share repurchases. The share repurchase figure includes $2 million for purchases in the quarter that were not settled until after the end of the quarter and so are not reflected in our second quarter statement of cash flows. In all, we repurchased 923,000 shares. We ended the quarter with $126 million of cash, $301 million of capital leases and $2.5 billion of term loan debt. With $600 million of undrawn revolver capacity, our $726 million of total liquidity affords us substantial financial flexibility to manage the business. Turning to our forward guidance on Slide 7. We are revising our fiscal year 2019 guidance to reflect a strong first half financial results and a positive forward outlook. We've taken out the bottom end of our previous revenue guidance and increased the midpoint by $25 million. We now expect pro forma revenue for the year to be $4.2 billion to $4.25 billion. Enabled in part by the $24 million gain from the contract divestiture in Q1, we now expect that pro forma adjusted EBITDA margin to be near the high end of a new range, 16.5% to 17%, compared to our previous guidance of 16% to 17%. As a result, we now expect pro forma adjusted diluted earnings per share of $1.85 to $1.95, again, taking out the bottom mark of our previous range of $1.80 to $1.95. Finally, we're increasing our guidance for pro forma adjusted free cash flow conversion for fiscal year 2019 from 90% plus to 95% plus of pro forma adjusted net income. Of course, pro forma adjusted free cash flow will benefit from both the increased conversion rate and the increasing adjusted net income. The guidance is supported by our $10 billion backlog, the $8 billion of proposals already submitted and awaiting decision, of which $6 billion is new business, and the $643 million of new business won in the second quarter. To provide a little more color, in the back half of the year, revenue should overcome the Q2 pull forward and remain fairly consistent with current levels in both segments. Similarly, adjusted EBITDA margin should be relatively steady with segment margins coming into rough alignment. As for cash flow, we've clearly had outstanding performance out of the gate. Year-to-date, we've generated $250 million of pro forma adjusted free cash flow, which is 152% of pro forma adjusted net income. The back half of the year will come down from that level of performance, especially in Q4, based on the timing of tax and payroll outlays. The multiple fiscal year ends across prospective and the legacy companies create a lumpy tax payment schedule for fiscal year 2019. In fiscal year 2020 and beyond, cash generation should be more uniform throughout the year. Finally, you'll see a number of filings from us tonight. As usual, we'll have the press release, 8-K and our second quarter, 10-Q. In addition, we'll put out an S-1 to register the shares for Veritas Capital, as previously disclosed. Because the S-1 references the last 10-K, we're also putting out an 8-K that recast FY2018 into our two segments. Operator, we are now ready to take any questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Edward Caso with Wells Fargo. Please go ahead.

[Edward Caso:]

Hey, good evening and congrats on another solid quarter here. Can you talk just a little bit about whether you feel comfortable that you've got enough margin flexibility to grow the company as you would hope? In other words, the promises out of the box, have they gotten you too constricted here in your ability to hit growth targets?

[John Kavanaugh:]

Hi, this is John. Thanks for the question. So yes, we feel good about this. Again, you saw again strong Q2 performance. We are continuing to invest in the business. It's all about accelerating growth. So again, given how we've performed in Q2, in the first half of the year, we feel good and consequently, have raised the lower end of the range and again, right now, expect to be at the high end of the EBITDA range.

[Mac Curtis:]

So Ed, this is Mac. Just to add on to John. When we think about the operations of the business and the pipeline, I think you look at it, 57% when you think about the fixed price, the pipeline is certainly supporting that. It's in the 60s, upper 60s. And we look at what we're looking at bidding now. So we're seeing the trend and more focus on kind of the firm fixed price. We've talked about that before. And so I think we feel comfortable where we are, not going to constrict the growth. In fact, we're starting to see more in the fixed price realm as we go forward looking at deals that we're going to bid on. So I think we have enough room.

[Stuart Davis:]

And as John like to say, this is absolutely not a cost play, but there are still some costs that we're delivering as part of our synergy savings. And we're, as John said, keeping the margin relatively stable, which means we'll have a little bit more money to invest in the growth of the business.

[Edward Caso:]

All right. My other question is on staffing ability, Perspecta does a lot of high end work, some highly skilled IT, cyber, so forth, capabilities. Can you talk about the market as it is today, the competitive market for talent and maybe a little crystal ball on implications of the Amazon arrival?

[Mac Curtis:]

So Ed, that’s a good question. I think that's one of the reasons why we wanted to highlight in the call this afternoon what we're doing with incentive programs, investor programs because it is a competitive environment. We want to be the talent destination. We've talked about in the business the right rewards programs because you have people, they want to come here, we talk about you don't have to lead to succeed. And so that's why we wanted to talk about that, and we've got some levers we can play with now. And it has to do with long-term incentive programs, short-term incentive programs. And again, I think we discussed that it's important to make sure we're lined up with investors and those requirements. But also to get the right people in the business that are willing to kind of bet on themselves. So that's why I wanted to spend some time to talk about that with regards to the talent that we look to require – we look to hire. And I think we're having some success, but you have to stay after it. On the announcement with Amazon, that does put stress on the system. It puts stress on 395. I mean, it put stress everywhere when you think about eventually adding another 25,000 people back into Crystal City. So I think those put stress on the system. And one thing I think is interesting is it's going to basically kind of push together the government customer and industry, those that really understand, kind of understand the mission. Because it is about the right talent to be able to deliver the mission. In the analysis, Ed, that we've done, roughly out of the 14,500 employees, just about 75% are not in the DMV. And so therefore, 25% is. And out of that 25%, for us, it's a pretty highly cleared workforce. Now it doesn't mean it's not going to put stress on the system. There's another player in the field, we get that. So we're looking at how you wrestle with that. It's probably only time in my career I've said I'm glad I'm 30 miles outside of Crystal City near Dallas. So – because that does – the community does play a pretty big role in the work-life balance. So again, stress on the system, but I think we have to be realistic about how we combat that. And the thing is that we really have this mission book. Our employees get the mission book whether it's in the classified arena or wherever it is. So we just have to stay after it – stick to our knitting. We want to be a company where employees want to come and stay, and so we just have to get everybody work on it.

[Edward Caso:]

Great, thank you.

[Mac Curtis:]

Yes.

[Operator:]

The next question comes from Joseph DeNardi with Stifel. Please go ahead.

[Joseph DeNardi:]

Hey, good evening everybody. Mac…

[Mac Curtis:]

Hi, Joe.

[John Kavanaugh:]

Hi Joe.

[Joseph DeNardi:]

When you gave your 3% to 5% revenue target that you were expecting growth in the budget in FY2020. And now, maybe the expectation is that it's flat to down. Can you just talk about your confidence in your ability to achieve those targets given what seems like a less favorable budget outlook at this point?

[Mac Curtis:]

Yes, Joe. Certainly, well, look, I think we're a long way from the FY2020 budget. We'll see what happens. I think we look at 2019, almost there, three quarters of the bills were signed, a couple are still kind of hanging out there. You're waiting for ag, and I think transportation, that's basically – that seem to have a couple that may be under kind of a CR. So I think we're a long way from getting 2020 done but a couple of comments, Joe. One, it's all about where you are in the market, frankly. And because we look at the budget, the military intelligence, those budgets are going up. I think the R&D budgets are kind of going up. So I think where we are in the digital transformation, cloud computing, cybersecurity, when we talk about the intellectual property and what is generated out of that. All those are in good spots because regardless of the budget, it's still a dangerous world out there. And whether it's data analytics that are required, algorithm development for bad people, dealing with cybersecurity, those things don't go away. So I think the point is that we're in the right spot in the market when you think about where we are in digital transformation, cloud computing, cybersecurity, et cetera. I think the other thing, particularly when you look at the DoD budget, Joe, I mean, it was $716 billion this year, right. And if you're thinking about going to $733 billion to $700 billion, you know they've talked about – Secretary Shanahan put two budgets out, $733 billion and $700 billion. So if it is $700 billion, that's a 2% reduction from $716 billion. And so I think we'll see how it all comes out, that's still a lot of money in the areas that we'd be. The one thing I would say, at least from what I've read and what I've heard, I think from the services, I think they're looking at it a little differently this time around. I don't think they're looking at it kind of a peanut butter spread. I think the Department of Defense is looking to make decisions on platforms. They're either going to sustain or not sustain orphan systems that are going to retire. So I don't think you're going to see where this 5% or whatever 2% peanut butter spread, it impacts R&D and operation and maintenance and ship billing conversion dollars. I think it's going to be really on specific systems. So again, I think in summary, we're in the right markets. I think we do the right functions in cyber and data analytics. A $700 billion budget is still a lot compared to a $716 billion budget this year. So we'll see. We're still very, very confident about our plan, what we projected in the future for the next two, three years, 3% to 5%. So we're sticking to our guns, no pun intended.

[Joseph DeNardi:]

So Mac, fair to say that even in the $700 billion budget, that your addressable market would continue to grow, that would be your expectation?

[Mac Curtis:]

That’s correct.

[Joseph DeNardi:]

Okay. And then you mentioned that the NGEN extension continues at work at the existing run rate. I'm just wondering if you could speak to your expectations for how that recompete is going to be split up and the relative size of the two pieces and whether you feel equally good about retaining those pieces or whether one is more likely than the other?

[Mac Curtis:]

Well, let me start at the top. And I go back to Joe, what we talked about at Investor Day and the thesis, what we laid out is exactly what's happening. So the NGEN program, as you know, that goes back to the EDS days. They've done great work for the Navy for the last two decades. They decided to come out with a procurement because they have to, because it's a competitive environment. It's a big program. And as we said in Investor Day, the NMCI program – or NGEN-R is coming out in two. They basically looked out and said okay, we're going to take the hardware, the laptops and those kind of things, we're going to split that out, and it's called EUH, end-user hardware, that RFP is out on the street. I believe it's due December 5. Okay, so that's one part of the equation, Joe. The other is SMIT, which is really the systems management, it's the integration, it's the transport, which is the bigger, the much larger opportunity. That RFP is out and that goes in, in January. So I think the way we've talked about this is when you think about EUH coming out, again, that's the hardware purchase, et cetera. SMIT, in addition to what we do now, there's additional work they're putting in. And there are a couple of other networks that they're looking at and some other things. So the way we've captured this is if you take EUH out, we think SMIT is going to be of similar size to the contract we're running now in the future. And I'll kind of leave it at that. So both are listed as best value, right, and I think that's a positive, that's different than what the contract was when it was bid in 2013, so that's positive. That allows us to make sure we can lean forward and provides a customer with the modernization and the technology need to operate the Navy and Marine Corps Internet. So I think that's the way it's kind of aligning. I'm not going to give specific numbers, Joe, because it is a competitive environment. But I think that – I'll leave it at that, Joe. Does that answer your question?

[Joseph DeNardi:]

Yes, that’s very helpful. Thank you, Mac.

[Mac Curtis:]

Okay. Very good.

[Operator:]

The next question comes from Lucy Guo with Cowen and Company. Please go ahead.

[Lucy Guo:]

Hi, everyone. Thanks for taking my questions. To start, not to dwell on your long-term targets, but given that you're updating some of the management comp metrics, just want to clarify, are those in line or maybe a little bit more ahead of your long-term targets for investors?

[Mac Curtis:]

Well, I think the intent, Lucy, for the management comp is to be certainly in line with the long-term plan. I mean, that's the way we've incentivized people, and there are nuances that you have to deal with. But I think the intent is management comp is consistent with what – with our investors so we can make sure that we can deliver and meet our commitments. So they – it should be in line. As you know, this can vary from year-to-year. This is the first time out of the box. We felt this was important because we want to incentivize people. We've taken it a little bit further down the organization because it is about building a company we're proud of. So the intent is to have it right in line with the commitments that we're making to the Street.

[Lucy Guo:]

And I may have missed this, but are you also incentivizing for bookings or backlog metrics and/or in terms of the long-term total stock return, shareholder return?

[Mac Curtis:]

Well, so I think the point here, Lucy, is when you think about it, you got a short-term, which is an annual bonus, you have long-term, which is obviously long-term. And what I did mention in the remarks is that there's also a business development program, and that's focused on a little different metrics, but it all ties together. When you think about bookings that you have to have, when you think about the periodicity of the contract, which is the denominator, when you do the math, it all has to tie to make sure we're meeting the commitments to the Street. So that's on a little different set but we lined it up, Lucy, the business development incentive program, the long-term, it all ties together because it has to. Because – and so again, mostly on, if you think about it, bookings is really important from a BD perspective. So I think that's the kind of the way we're thinking about it.

[Lucy Guo:]

That's helpful. On your second half bid pipeline, the submits that you're planning on, is that still $15 billion to $18 billion, and that seems to include the submit, right, in January?

[Mac Curtis:]

Yes. I think that's about – yes, we've got roughly – we've got eight now, and we're probably looking anywhere from 14 to 16 to eight because we're not going to bid everything in the $60 billion pipeline. And some things move to the right, of which we don't control, and so things change. But yes, it's about probably $15 billion to $18 billion is what we're looking at in the second half to submit. That's a good number, including NGEN.

[Lucy Guo:]

Got it. Maybe one for John, and I'll turn it over, which is your capital lease payments, the disclosure from the last Q, I've been taking a look at the Q that just came out here, but it seems to indicate from FY2019 to FY2020, there's about a $80 million or so of tailwind to your free cash generation year-over-year. Is there anything that's offsetting that? Or are you just kind of being conservative on your free cash conversion targets?

[John Kavanaugh:]

First off, again, that's attributed to again what we've talked about before, the off the cap lease changes that was done last year. Again, capital leases are more appropriate accounting treatment for the longer-term nature of the work that we're doing in refresh cycles, okay. Now I guess as I said in my prepared remarks, very, very pleased with the cash flow performance and certainly the working capital management. But as I stated, in the second half of the year, again, we will see it coming down. There are, especially in Q4, tax payments and favorable outlays. So again, we got a quarter under our belt. I think, again, we've done the appropriate thing in raising guidance at this point. But at this point, we're just going to continue to monitor and advise appropriately.

[Lucy Guo:]

Got it. Thank you. I’ll get back in the queue.

[John Kavanaugh:]

Thank you, Lucy.

[Operator:]

[Operator Instructions] The next question comes from Krishna Sinha with Vertical Research Partners. Please go ahead.

[Krishna Sinha:]

Just a little bit more color on your operating segment margins. The margins eased sequentially on an adjusted pro forma basis, especially in your civil and health care segment. And – but you also stated that – in your prepared remarks, John, I believe you said that the margin was going to converge between the segments throughout the year. So a, what was – I’m assuming it was integration and restructuring expenses that affected the segment operating margins this quarter. But when you say converge, converge around what sort of number are you thinking for the forward metrics?

[John Kavanaugh:]

Good question, Krishna. So let me level set. So the sequential margin change, okay, is really what I would say nonoperational. It was really to better align directly segment costs. More specifically, we're 30 days in, and Q1 costs were really aligned based on revenue percentage. Now we have a much better direct relationship. So therefore, what does it mean, okay? So the margins that you see in Q2 are much more indicative, okay, of our operational performance. And I think going forward, in each of those segments that will be a good comparable on a sequential basis. So again, I expect us to be right again in the defense and intelligence in that 13%, low 13% range and in the civilian and health care, again, hovering around 13%.

[Krishna Sinha:]

Okay. And then, excluding the very chunky NGEN recompete in this quarter, what's your overall recompete win rate looking like now relative to sort of industry benchmark of 90%?

[John Kavanaugh:]

It's above 90%, Krishna. It's in the low to mid 90s is where we are right now.

[Krishna Sinha:]

So then when you think about your forward, I think you said 27% new business wins, that's right at the sort of target that you were expecting. Are you seeing anything, either on the upside or the downside on that new wins target? And do you need to do better than 25% to hit that top end of your revenue CAGR?

[John Kavanaugh:]

Yes, I think the way we laid the model out is that between 25% and 30% because some of the deals are bigger than others as you would expect when you think about it, so I think 20% – it will be 25% and 30% is kind of at the high end. I think 25%, the way we've modeled it over the next three years, we should win – we'll be at the 3% to 5% is the way we've laid out those numbers.

[Stuart Davis:]

But to be clear, Krishna, when we talked about 27%, that was 20% of the total new business, not that we won 27% of the new business bids we went after.

[Mac Curtis:]

So again, that's a good point. So on the book-to-bill, 2.3, it's a two-point – roughly $2.4 billion of it was one, 27% was new business. I think that was $640-and-some million was net new that runs out. Is that – maybe I'm confusing the issue.

[Krishna Sinha:]

Yes. Okay. Well, in that case, what – against the new business wins that you were targeting, which is 25% in your investor presentation, what's the apple-for-apple comparison now to what you're winning?

[John Kavanaugh:]

So let me level set, Krishna. So relative to the revenue, again, we've raised the lower end of the range. So what I would say right now is you'd be thinking about the go get to the new midpoint, right, based again on our strong Q2 bookings. We've got a little less than about 2%, okay? And most of that, I think, will come from recompetes or from our contract growth. When I look at the new business, that's about less than half of that two-ish percent to get towards the midpoint. And again, as I said in my prepared remarks, again, based on performance in Q2, we are certainly expecting to be at the higher end of our revised revenue guidance.

[Mac Curtis:]

So I think the answer to your question is simple. It's about 25% is what we've modeled to be at the high end of the 3% to 5% going forward.

[Krishna Sinha:]

Okay, fair enough. And then one more quick question. You mentioned $13 million in revenue pull forwards. What was the operating income impact of that $13 million pull forward?

[John Kavanaugh:]

Yes. It was fairly minimal, a lot of it was passed through, so it was fairly immaterial.

[Krishna Sinha:]

Okay, thank you.

[John Kavanaugh:]

Thank you.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Stuart Davis for any closing remarks.

[Stuart Davis:]

Well, operator, Gary, we really appreciate your assistance on today's call. Thank you, everyone, that was able to join the call. I'll be around after the call if people want to do some follow-ups, and we look forward to catching up with you guys out on the road.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.