Operator:

Greetings. Welcome to Leidos' Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I'll turn the conference over to Stuart Davis from Investor Relations. Stuart, you may begin.

Tom Bell:

Thank you, Stuart, and good morning, everyone. It's great to be with you all again today to report a record quarter for Leidos. In this quarter, organic growth remained strong, achieving a record adjusted EBITDA margin of 13.5%. Year-to-date, we've delivered industry-leading profitable growth, with adjusted diluted EPS 50% higher than last year. The team is doing an excellent job converting our earnings into cash. In turn, this has allowed us to continue to deploy capital to grow shareholder value per our plan. We're now halfway through our commitment to repurchase $500 million worth of shares this year. I'm also proud of the fact that this robust first half of 2024 allows us to once again raise guidance for the full year. Chris will give you a complete update on our financials and our guidance later in the call. One year ago, on my first call with you all, I laid out four focus areas to begin Leidos' journey to best-in-class performance. Instilling in Leidos a "Promises Made, Promises Kept" culture, sharpening our strategy, improving the performance of previous acquisitions, and enhancing our ability to win new business. I'd like to take this opportunity to update you on the meaningful progress we're making in these areas. I see this progress as foundational to putting ourselves in a great position to execute our forthcoming Leidos North Star strategy. First, our team has fully embraced a "Promises Made, Promises Kept" philosophy. As part of this, we've made a firm commitment to each other to drive operational improvement, profitable growth and robust cash conversion. The evidence of this culture taking hold is clearly visible in the 12-month trend of our results, and our second quarter results, summarized earlier, that are simply our best yet. Our currently strong and strengthening balance sheet puts us in an excellent position to continue to allocate capital prudently over time to grow shareholder value. Further share repurchases this year are possible, but at the same time, I must say that our new North Star strategy work is beginning to bring into focus exciting and compelling growth opportunities potentially worthy of investment. This brings me to that second focus area, creating our new North Star strategy. While we continue to deliver robust in-year program execution, we are also aggressively prosecuting our year of deep strategic thinking. And the energy and insights that are beginning to come into focus because of our purposeful strategy process are very intriguing. We've now completed work on the Leidos proprietary hypothesis of the future, our own exclusive prediction of the challenges our customers will face, the solutions those challenges will require, and the technologies we must create and harnessed to best differentiate our solutions for our customers. Informed by our hypothesis of the future, we're now halfway through crafting a new business strategy for Leidos. This strategy will both leverage and enhance our current core businesses and uniquely position us for outstanding success in the future we foresee. One clear component of our strategy will remain our focus on technical differentiators, our golden bolts. Technological innovation is and will remain a cornerstone of Leidos. And our enterprise-wide technology investments are now more than 1% of total revenue and growing. At our recent Investor Technology Day, we went in-depth on one of those golden bolts, Trusted Mission AI. Those of you who were able to join us witnessed firsthand our brilliant team in action, demonstrating how we use Trusted Mission AI to drive productive disruption across our customers' missions. We believe that when it comes to AI, the mission is the market. So, everything we do as the number one provider of IT to the federal government and the number eight US defense contractor is an opportunity to exploit and deploy Trusted Mission AI for our customers' mission benefit. Another area of proactive investment for us remains cybersecurity. For instance, we've been investing in Zero Trust for years before there was a requirement for it to be adopted by federal agencies. As a result, over the last three years, we've received more than $5 billion of awards that cite our Zero Trust methodology as a differentiated strength. We're currently pioneering the application of quantum technologies to enable highly secure networks. We're executing contract R&D for DARPA in this area and investing in post-quantum encryption technologies and solutions. These will ensure our customers can rapidly respond to future developments in quantum computing. These examples give you some understanding of our forward-looking approach to the market and our track record of investing ahead of demand. Third, we're on track to unlock the strategic value from the large acquisitions we made in 2020 and 2021, specifically Dynetics in security, detection and automation. On Dynetics, we have doubled down on three specific areas, each of these now on a robust positive trajectory. In satellite payloads, we're a key supplier to the Space Development Agency's wide-field-of-view sensor program within its proliferated warfighting space architecture. We have delivered all our payloads for Tranche 0, and those payloads were the first ones in low-earth orbit providing SDA actual on-orbit imagery. In addition, we remain on track to deliver our Tranche 1 payloads in early 2025. And we are teamed with Sierra Space to be their payload provider on their Tranche 2 birds. The Space Development Agency has recently issued their RFI for Tranche 3. So in sum, we believe our current comprehensive role on all three existing tranches and our current actual mission performance in space position us well to continue to deliver for this critical and expanding mission. On force protection, we've delivered 14 IFPC Enduring Shield prototypes, which are successfully working their way through government testing. The Army recognizes this system's unrivaled air defense capability, and we expect to receive awards soon to begin low-rate production in 2025 and full-rate production in 2026. And in hypersonics, the United States continues to progress in developing and fielding hypersonic weapons. Leidos is supporting this progress by developing -- excuse me, delivering technology advances through our Common-Hypersonic Glide Body and MACH-TB programs. These programs play a critical role in accelerating the pace and scale at which we can produce, test, assess, advance and field our nation's hypersonic capabilities. We remain on track for our Common-Hypersonic Glide Body and thermal protection systems delivery. And all in all, we feel quite positive about this robust pipeline of opportunities in hypersonics. So, 2024 maintains its promise to be the good year for the maturation of these programs. And we're also seeing our focus here translate into better financial performance. Our Defense Systems profitability was double-digits in the quarter, our first time at that level of performance from as far back as we recast financials in the new organizational structure. Turning to security products, the SD&A acquisition is now fully integrated into our SES business area. Though challenges remain, SES is on sound footing because of the swift actions of our new management team that they took last year. We have focused our efforts and investments in product lines and geographies that make the most sense for Leidos and therefore, our shareholders. Our new Charleston manufacturing facility is up and operational, and we're performing better against our service-level agreements with our customers. We've had solid bookings this year and more consistent deliveries of large border solutions. As a result, SES is ahead of plan for revenue and earnings for the quarter and the year. SES revenues are up 11% year-to-date and we've achieved almost 90% of last year's non-GAAP profit in the first two quarters of 2024 alone. A common theme of this improved acquisition performance is the new organizational structure, which brings better alignment of sector resources and new leadership with an increased emphasis on execution and Promises Made, Promises Kept. Fourth, we continue to make significant progress to enhance our business capture performance and backlog quality. We've achieved net bookings of $4 billion this quarter with a heavy emphasis on cyber and dig-mod awards for a book-to-bill ratio of 1.0. We also have nearly $3 billion of awards currently under protest. We ended the quarter with total backlog of $36.5 billion, including $8 billion of funded backlog. While this quarter's performance adequately supports our 2024 growth commitments, we are not at all satisfied, and our growth teams have been working diligently to reignite our winning ways here at Leidos and do much better on top-line growth soon. An element of this is strengthening our customer-centric framework of account management. Over the past six months, we've hired dozens of key account managers and frontline growth leaders, each with deep mission and customer expertise in areas of strategic importance. Each of our account managers have a frontline obsession and seamlessly integrate across both our P&Ls and our office of technology to ensure we couple best-in-class teams with best-in-class technical solutions. Two examples which illustrate this point are our recent hires for INDOPACOM and AUKUS. Because of their respective hard work in very short order, we've won strategic awards to support military exercises that are fundamental to the US Pacific deterrent strategy. Maritime autonomy and undersea sensors work in Australia and hypersonics work in the UK that fit within AUKUS Pillar 2, and US Navy submarine trainer development efforts that fit within AUKUS Pillar 1. We've taken the further step of dedicating some 100 of our top engineers and solution architects to our frontline growth efforts. Operating in full partnership with our account managers and capture teams, they are positioned to bring the best of the best of Leidos to our customer needs. With the improvements we're making in the growth value stream, we are getting set up for a much better business capture performance in the future. At quarter's end, we had $26 billion worth of bids awaiting adjudication. And more importantly, quality is improving dramatically. Our pursuits are more aligned with our strategic direction, our proposals demonstrate greater customer understanding, and we are doing better at pulling through enterprise-wide technical expertise into each customer solution. So in summary, I'm very pleased with our financial results this quarter and the momentum that we're carrying into the back of the year. We're making great progress on our current four focus areas. This puts us in an excellent position to execute our emerging Leidos North Star strategy. I'm very proud of the 48,000 Leidos teammates who collectively every day ensure Leidos is making smart smarter for the benefit of our customers. And I'm honored that every day more and more of the best of the best wicked smart people in the nation join Leidos to break limits. I'll now turn the call over to Chris to walk you through our financial results in detail. He'll also provide insight into our upgraded outlook for the year and then we'll be pleased to take your questions. Chris?

Operator:

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] And our first question coming from the line of Mariana Perez Mora from Bank of America. Your line is open.

Tom Bell:

Good morning.

Tom Bell:

Thanks, Mariana. Really appreciate your question, and obviously, a part of the portfolio we're very, very proud of. The performance we're achieving in this part of the business is directly related to our passion to serve the nation and its veterans and our investment in technologies ahead of curve, so that we were poised to take additional volume as we came out of COVID and had an opportunity to serve more and more veterans. We're very proud of this and we're very proud of those investments that allow us to serve more veterans. And our modeling for what the output and input of veterans that need case management increases and stays the same over the coming years. So, we're very bullish on the absolute volume. What we're doing to affect our future in that overall volume is ensuring that VA sees us as their partners. So, we've leaned in to help make sure that they understand we are invested in their success and their budgetary challenges that they have right now. And that positions us well for this recompete that's coming in the third or fourth quarter, probably more like the fourth quarter. We expect the customer to expect us to continue to serve the veterans the way we are and we're very bullish about the opportunity for us to continue to invest in technologies that serve our customers even better. So, the challenge that we've given Liz and her team is not how to hold on to this business, but how to increase this business over time. So, as part of our year of deep strategic thinking, we're not seeing 2024 as the peak of this business. We're seeing it as a plateau of this business from which we continue to springboard. That's the challenge we've given Liz, and her and her team are responding very favorable to that. Chris, do you want to add anything?

Mariana Perez Mora:

Thank you. And if I may, my next question is about the -- as you focus on the account managers and capture these teams, what are the challenges you have on hiring and training the talent, both internal and people that you hire?

Chris Cage:

The only thing I'd add, Mariana, to that is, of course, a very good question, and Tom is right, I mean screening the right people to have the passion to want to serve the right customers' missions is critical. The area that we need to help them the most as they get into Leidos, there's clearly a tremendous amount of capability that we have that can be brought to bear to support those customers in multiple ways. Helping them understand the breadth of our offerings is an area that we are continuing to invest in and that's the reason why partnering them up with so many solutions, architects and other people that have been down that road is critical, but there's technology that's behind that as well. So, Gerry Fasano leads our growth office. He's very focused on that rollout plan and we're excited about that taking a lot of momentum here in the second half of the year.

Operator:

Thank you. And our next question coming from the line of Matt Akers with Wells Fargo. Your line is open.

Tom Bell:

Sure, Matt.

Tom Bell:

Yeah, sure. Thanks, Matt. As I said in my prepared remarks, we're done with the Leidos proprietary hypothesis of the future. This is our own exclusive proprietary view of what the world looks like in 2033 and therefore, what are the challenges our customers are facing in 2028 in order to affect that future. We're halfway through building our business strategy as a result and affected by that view of 2028. So, it's very much a today forward view and a future back view meeting in 2028. As we are starting that, Chris trailed in his comments that we've put a small investment fund out there, because ideas are starting to emerge from this year of deep strategic thinking that we know are winners. These are areas that we are going to be investing in, in the future. And although we're not going to articulate it, we're putting seed corn out there now in those areas, so that we're not waiting for the whole process to be done to do the obvious compelling things we want to do to affect our future here. So, we're very excited about that. Now, the overall objective and the parameters of our year of deep strategic thinking, I think I mentioned it in our last call, it's not going to be a pivot for Leidos, a 90-degree pivot or 180-degree pivot, it's going to be variations on the cores that we're in now. And so, we're going to be doubling down on our core strengths. We're going to be really focused on repeatable business models. We're going to really focus on speed. We know that our customers are very concerned with speed, but they're concerned also that the people they hitch their wagons to have to have the scale to solve complex problems differentially. So, speed and scale. Trusted Mission AI, there's a reason we had a whole day focused on Trusted Mission AI, because we think it is a compelling technological unlock for the futures our customers are facing across all the markets that we serve. And we're going to continue to look for those areas of white space that are adjacent to the current businesses we're in for investment. Now, obviously, Matt, in the spirit of your question, there's also going to be parts of the portfolio we are not going to differentially invest. I've mentioned this in calls last year. I do not believe in spreading peanut butter around and watching every flower bloom. I think all about differential investment for differentiated results, but there is also not any part of the business yet that is raising its head in the strategy process is saying it's obvious this does not belong in Leidos. So, don't think of this as portfolio pruning. Think of this as simply investing to maintain, investing to grow and investing to grow exponentially. That's the way we're thinking about our strategy process. All that will be discussed at full in our March Investors Day that we look forward to welcoming you to.

Chris Cage:

Yeah, Matt, obviously, we talked a little bit, of course, about the VBA exam business and that's top of mind as we navigate to the end of Q3 into Q4. Beyond that, I mean, there's not as many needle movers. There is an exciting opportunity in the hypersonics arena where Common-Hypersonic Glide Body and TPS contracts converge and we look forward to extending our work there with an important customer. There is an integrated logistics support contract with the TSA that -- whether it's late this year or first quarter next year and obviously, you can imagine that's a partnership between our C&I business and work we do elsewhere that specializes in the logistics side. And then, looking ahead to next year, I think the other big one I'd point out is the DHMSM contract. The follow-on to that obviously is an important piece of work for us. The team is already in the proposal bids, making sure that we're putting our best foot forward, but that is sometime in the middle of 2025 -- early-to-mid '25.

Matt Akers:

Great. Thank you very much.

Operator:

Thank you. And our next question coming from the line of David Strauss with Barclays. Your line is open.

Chris Cage:

Good morning.

David Strauss:

A question, Tom, on National Security and Digital. I think you guys hit on the slow growth there in the first half, but it sounds like you're talking about an acceleration in the second half, but at the same time it sounds like you're signaling lower margins in the second half. So, could you just dig in exactly kind of what's going on there in the second half versus the first half? Thanks.

Chris Cage:

Yeah, David, I'd just add on to that. I mean, I think part of that is because we had an excellent first half of the year on margins. And there are some things that can move around, around milestone timing and things of that nature and how much special project work we see on programs like NGEN, but there's no fundamental issues here. And, in fact, we're actually very encouraged, to Tom's point, this will never be our highest-margin business, but we do see upside here over time and the teams are investing in more repeatable models in the dig-mod space and those will be some unlocks to future margin upside that we're expecting. But I don't want to overlook some important wins that did take place in the quarter. Getting the next Defense Enclave Services task order under contract is critical for us. That is a key unlock for Steve and his team to drive growth into that important program. So that clears the way for 13 additional DoD Fourth Estate agencies to migrate on to the network over time. So, we've been waiting for that and we're excited about what comes behind that as we get into '25 and beyond.

Chris Cage:

Yeah. So, I'm very pleased with the team's performance on cash management. I think we've done an excellent job. And last year, we made some really strong gains on managing the payable side and more industry standard terms with our vendors, and we've made some more progress in that regard this year. We've been attacking the DSO side. I would say, it's steady as she goes. I don't see anything at this point in time that would be a major use of working capital. We're always interested in great ideas that could be accretive to the business. But right now, we're focused on Q3 and Q4 are usually our strongest performance quarters and I expect this year to follow suit.

Operator:

Thank you. And our next question coming from the line of Cai von Rumohr with TD Cowen. Your line is open.

Tom Bell:

Thank you, Cai.

Tom Bell:

I hate to answer your question this way, but we don't know is the real answer, because we're awaiting the RFP that tells us what the customer actually wants to do. We know that the contract comes to an end at the end of this quarter. We are awaiting the RFP for the future. We're not sure if that's going to be -- if we're going to have an extension to the current contract, a new contract for a fixed period of time or a new contract for a long period of time. And we don't know how the VBA is going to incentivize industry to bring its best and its most throughput to our veterans. So, we have no reason to model, in our own minds, a decrease in profitability, but there is a big unknown while we await the RFP.

Cai von Rumohr:

Perfect. One quick one on your new business. You had $15 billion of submits, you have $26 billion awaiting. What should we think about in terms of your book-to-bill? You also have $3 billion in protest. I think there's a big classified award in there. Should we see book-to-bill pick up in the second half? And are you guys chasing some of the large takeaways you've been so successful in?

Cai von Rumohr:

Terrific. Thank you so much.

Peter Arment:

Yeah, thanks. Good morning, Tom, Chris, Stuart.

Peter Arment:

Terrific results. Hey, Tom, maybe just the focus on Commercial & International, just you had the write-down in the quarter. Absent the write-down, you would have had pretty good margin performance. Maybe just talk a little bit about, I guess, either the write-down or just confidence level in kind of the back half of the year, where your margins are, I guess, expected to be better? Thanks.

Chris Cage:

The only thing I'd add there, Peter, is the piece of the business there that Tom didn't mention is our commercial energy business and that has been performing extremely well and tends to have a pattern where the back half of the year is stronger on a margin basis. There are some critical incentive and award fee determinations that happen sometime later in the year. So, a well-run business that we expect to continue to deliver great results, and the other piece of the portfolio we believe are on strong footing for the second half.

Tom Bell:

It's a very timely question, Peter. I have a classified briefing later this week to dive deep into all our capabilities for Counter-UAS. Obviously, IFPC and Enduring Shield is the thing we talk most about, about Dynetics. But within our Leidos Innovation Center, the LInC, and our Defense Systems segment, we've got a myriad of other technologies that can affect Counter-UAS capabilities for our customers. So, we're going to take a step back, kind of look at everything that we've got in the pantry when it comes to technology and decide, are there some things we should be investing in this year to help our customers with this very, very vexing problem that they're uncovering now. So, very bullish about our opportunity to serve. The question is, do we have something in the pantry that will be compelling for the customer.

Tom Bell:

You bet.

Jeremy Jason:

Hi. Jeremy Jason from Jason Gursky's team.

Jeremy Jason:

Hello? Sorry.

Jeremy Jason:

I kind of have a math question. Could you walk us through the pipeline for each of the segments for '25 and '26? And kind of give us an update on production capacity and how that might impact growth outlook? Thanks.

Tom Bell:

And just to pile on a little bit on that, Jeremy, the $26 billion of pending awards we have, I mean, that is not only several home runs that we've got on deck, but 40, 50 big awards of $50 billion -- $50 million or more. So, we've got lots of proposals in work. And so, the batting average should be relatively positive on that. We've used the example internally of -- we've had a business capture problem and so to break that inertia, we have inputted energy, energy with new talent, energy with new processes and tools. And now we're very excited about the momentum that's going to build over the next 12 months to 15 months. You'll appreciate that in our customers' environment decisions take time and ultimately they're almost all protested. And so, it takes a little while before the flash of energy to break inertia becomes the bang of the momentum of actual wins, but we're highly confident that we're in a good place and Gerry is the right leader to bring us forward.

Tom Bell:

Thank you.

Ken Herbert:

Yeah, hi, good morning. Tom and Chris, really nice quarter.

Chris Cage:

Thanks, Ken.

Chris Cage:

Yeah. Hey, Ken. Chris here. Obviously, we stepped up our cash guide last quarter by $200 million, a pretty significant increase. We're clearly focused on converting these extra earnings that you're going to see here into cash and there's always the chance that some of that comes in January versus December. So, at this point in time, with two quarters to go and two-thirds of our cash commitment for the year ahead of us, we just didn't feel it was prudent to increase the guidance at this time. But there's no headwinds that we're foreseeing, we're just kind of managing it down the middle.

Ken Herbert:

That's great. Thanks, Tom. And if I could, it sounded like from your prepared remarks that there could be upside as well to the expected buyback this year, the $500 million. I guess maybe part of that's timing, but can you just reset in terms of what you might want to see to deploy more capital there? And maybe any change in how you think about the framework around returning capital to shareholders considering some of the investments you're talking about here today? But great, great cash in the quarter, really nice.

Ken Herbert:

Perfect. Thank you.

Operator:

Thank you. And our next question coming from the line of Noah Poponak with Goldman Sachs. Your line is open.

Tom Bell:

Hi, Noah.

Chris Cage:

Sure. No, thanks, Noah. And we get it, right, excellent first half of the year, excellent full year guidance, but the second half relative to the first half looks a little bit more modest. But stepping back, the guidance implies, let's call it, roughly 11% margins in the second half of the year. And just six months ago, we opened the year with an expectation of 10.5% to high 10%s on margin. So, we're pleased to be able to look ahead and say, even in a scenario where the disability examination work levels perhaps come down, we still see line of sight to, let's say, 11% margins kind of being delivered by the business. And that's really the primary reason, right? As we look at as the VA is kind of navigating the next few months, we're expecting those throughput to be lower, and then we've allowed ourselves some cautiousness as we look into the fourth quarter around how quickly that will snap back. So, there are certainly scenarios where that could do much better, but that's the primary backdrop. As we look at the rest of the portfolio, obviously, we did signal that National Security and Digital has had a very strong first half on margins. There's always the potential those are able to sustain at those levels, but again, looking at some of the milestones, we pulled back a bit on that for the second half guidance. And then, the last piece, Noah, that I'd point to is the investments. Taking advantage of this opportunity to make sure we're funding an innovation fund that we can dial up or dial back depending upon the progress that's being made and really make sure that we've got a jump start on 2025. So, the fundamentals of the business across the board are in great shape. We feel good about that. In fact, there are some areas still on the optimization side that we still have ahead of us to get after on indirect cost management. So, I feel like we're really well positioned as we look ahead at '25.

Noah Poponak:

Okay. And Chris, the VBA, I guess, it sounded like you guys are saying you don't have an RFP yet. It sounds like recompetes imminently without an RFP yet.

Noah Poponak:

It's maybe unlikely, I don't know. Is that sliding out? Does that make an extension more likely?

Noah Poponak:

But you still expect them to slow down the activity while that's being sorted out?

Noah Poponak:

Okay. Thank you.

Tom Bell:

Olivia, it looks like we've gone beyond the hour. So, I think we'll call the Q&A at this point. So, I want to thank you for your assistance on the call and thank everybody on the call today for your interest in Leidos and we look forward to catching up with you in the future.

Operator:

Greetings, and welcome to Leidos First Quarter 2024 Earnings Conference Call. At this time, all participants are in a lister-only mode. A brief question-and-answer session will follow the formal presentation. Please note this conference is being recorded.

Stuart Davis:

Thank you, operator, and good morning, everyone. I'd like to welcome you to our First Quarter Fiscal Year 2024 Earnings Conference Call. Joining me today are Tom Bell, our CEO; and Chris Cage, our Chief Financial Officer. Today's call is being webcast on the Investor Relations portion of our website, where you'll also find the earnings release and supplemental financial presentation slides that we'll use during today's call.

Thomas Bell:

Thank you, Stuart, and good morning, everyone. It's very good to be with you again today. And I'm thrilled to report a very robust start for Leidos in 2024, a substantial raise to our full year guidance and some additional details around the purposeful steps we're taking to position Leidos for an awesome future.

We are achieving and propelling superior profitable growth by focusing on 3 key elements:

first, continuing to unlock full value and flawless execution in our new capabilities-focused organization; second, increasing investment in distinct organic disruptive technologies; and third, developing a robust value-creating, merit-based Leidos' profit and growth strategy.

Operator:

[Operator Instructions]

Bert Subin:

Tom, when you started, I guess, about a year ago, you said you wanted to evaluate allocation of capital to each business based on the business case supporting the return on capital for each. It would seem like capital is being put to best use right now in Health and Civil. Is that a near-term phenomenon being driven by the PACT Act? Or is there a case for that business to be your fastest growing and most profitable longer term as well?

Operator:

Our next question comes from the line of Tobey Sommer with Truist Securities.

Chris Cage:

Yes, Jasper, thanks for that, right. Obviously, we're very pleased with the start to the year. And as in our prepared remarks, we indicated it wasn't just the Health and Civil business. It was really all of our teams got out of the gate strong.

Chris Cage:

Yes. The Civil part of the portfolio has some excellent programs in there. And as Leidos and the team are bringing that all together, it's more about the energy and the synergies that we see across those businesses on personnel and in software capabilities that can be extended to both sides of the equation. I wouldn't think there's any particular standouts in the Civil portfolio. It was a solid first quarter out of the gate.

Thomas Bell:

But I can't let that question not go without a little bit of a foot stomp on the great performance we're having in the Health side of the business. We are continuing to invest in innovation there. And some of the innovations that Bert asked us about before that were built during the COVID crisis puts us in this position to do exams better for the VBA and some of the results that are behind the financial results are that Leidos investments have allowed us to increase the total number of veterans served by 27% in 2023.

Sheila Kahyaoglu:

Kudos to the Leidos Board for choosing the right candidate, clearly, Tom, great results, the whole Leidos team. So maybe on Health, we talked about it a little bit and Chris mentioned it in his remarks in terms of the PACT Act moderation. Can you maybe frame how we should think about the upside and downside scenarios there?

Chris Cage:

Yes. So I mean, a couple of things we're tracking, and Cindy, leading that business is all over this with her team. But as we said in our remarks, we're actually pleased with the way we performed out of the gates in the first quarter. We're ahead of pace.

Thomas Bell:

Yes. And just to foot stomp that a little bit, Sheila. I mentioned -- as I foot-stomped an earlier comment about all the businesses keeping up with their commitments to Chris and I for their full year performance and the promises-made, promises-kept modus operandi, and I'm very happy to report that Cindy is amongst them, undeterred by a less robust start to the year than perhaps we might have hoped for, but very committed to the full year results, and she and her team are committed to meeting or exceeding those.

Rocco J Barbero:

This is Rocco for Seth. On margins, milestone achievements supported the National Security and Digital margin in the quarter. Should we expect additional milestones in the coming quarters? Or should the margin rate there normalize? And then on Health and Civil, Q2 is expected to be as stronger as Q1, but should we think about the back half falling into the mid-teens on margins [ seen as strongest ] in the business, obviously, pending the recompete?

Thomas Bell:

I would just say that my whole promises-made, promises-kept culture, never uninvites overperformance. And so overperformance is welcomed. Overperformance is understood as a goal we all look to achieve and I have every confidence, Roy and his team are going to work to overperform both in this year and the future. We haven't talked about it yet, but our business development pipeline is very exciting and very robust.

Rocco J Barbero:

Great. And then should we expect hypersonics to drive Defense Systems growth this year or when the business is changing to limit growth?

Matthew Akers:

I wonder if you could comment on the security products business. I think you said in the prepared remarks, there's still work to be done optimizing that. So I was just curious if you could touch on -- I think you are in-sourcing some products you talked about that last year. And then kind of how big should we think about some of these products that you've decided to exit?

Matthew Akers:

Great. And then I also want to ask on CapEx. A little bit of a slow start to the year. I might have missed it, but is the $190 million still the right way to think about that for this year? And does that sort of ramp up the year?

Thomas Bell:

Chris mentioned San Diego a little bit. I'll just foot-stomp the great job the team is doing there. We're building a facility that will be world-class in terms of security and up to the latest standards of our nation. And so we'll have facilities on the West Coast that are as good as any and better than most. And we're very excited about the conversations and the opportunities that will unlock for us with our customers and the opportunity, therefore, to serve them at the highest classification levels.

Noah Poponak:

So I guess on the margins, in the quarter, the total company EBITDA margin over 12% despite what you're saying about Defense Systems and the back half of last year kind of mid-11s with the same thing and a little bit more normal Health margin. I guess just without even putting a time frame on it, but just as you go forward beyond this year, should we all be thinking of Leidos as a 12% plus EBITDA margin business? Or is that getting ahead of ourselves, depending on where Health and Civil shake out?

Thomas Bell:

And yes, we've put the right team in place to execute the vision for us being a growing business profitably, focused on profitable growth. And so the pipeline is being refined to go after aggressively the right business, not all business. You remember one of my sayings, not all business is good business. And for Leidos, people understand that message and our priming the pump of the pipeline accordingly. We've got a healthy backlog, as you rightly call out, I'm not a big fan of these quarterly book-to-bill ratios because they are a fool's mission.

Cai Von Rumohr:

Tom, good work on medical exams, terrific numbers. So you mentioned that you're approaching the ceiling on the medical exam. Can you tell us approximately when you might hit that ceiling? And can you give us any range of time frame in terms of when we might expect a new RFP?

Cai Von Rumohr:

Got it. And so you've done way better than most of the other services business. Is there any risk or thought that because you're doing so well that the next bids might be structured so that there's not the same profit opportunity because obviously, I would assume, this has got to attract lots and lots of bidders. Or do you have any visibility at all or thought about how the VA might structure the next RFP?

Operator:

Our next question comes from the line of Robert Spingarn with Melius Research.

Chris Cage:

Rob, it's a good question. It's a good insight. I think we take the view that you've got to play the long game here. I mean if we were worried about maximizing the dollar on the current book of cost-plus contracts, I think that'd be a little bit shortsighted.

Robert Spingarn:

And that's a real interesting answer. And then, Chris, just not so much following on to that, but talking about cost plus, again, I think if we look at the other side of that, I think, around 40% of revenues are fixed price. So a pretty meaningful portion. I'm wondering, I want to ask you about stale backlog. If the backlog reflects that 40%, in other words, it's similar to the revenue profile. Is there any portion of that, that has pre-inflation pricing where you'd get a natural lift in margins as that work rolls off over the next couple of years and things are repriced post-inflation?

Operator:

Our final question comes from the line of Jason Gursky with Citi.

Thomas Bell:

Yes, it was a somber sobering affair. For those of you who haven't picked up the magazine that they published at the beginning, the title of the conference was lose-lose question mark. So that gives you a sense of the tone earlier this year. And I don't think that, that has become any more joyful.

Thomas Bell:

Yes. So we're doing reasonably well in defending the work we have. Our recompetes and on-contract growth is good, and we are very happy with our performance there. The retooling in our business capture and growth areas is all about going after the big game and making sure we put ourselves in a position to robustly prosecute new opportunities for Leidos.

Chris Cage:

Yes, Jason, just quickly, I mean, I'd say that certainly, best value or decisions are the trend we continue to see. And I'm not seeing any Crazy Ivans and the competitive set is pretty well known and understood. We pay a lot of attention to that. Oftentimes, it just comes down to are you writing a compelling proposal, getting clarity of what your solution, and do you have the unparalleled customer understanding that you need to really hit the mark on the things that they're looking for that might not have jumped out in the RFI.

Operator:

This concludes the Q&A portion. I'll now turn the call back over to Stuart Davis for closing remarks.

Operator:

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.

Operator:

Greetings, and welcome to Leidos Fourth Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Stuart Davis, of Investor Relations. Stuart, you may begin.

Tom Bell:

Thank you, Stuart, and good morning everyone. It's good to be with you today to report another strong quarter for Leidos and to put a bow on a very successful 2023. I'll frame my part of our conversation today in three parts. First, our 2023 results; second, the progress we've made towards building a brighter future; and third, what you can expect from us this year. First in our fourth quarter we delivered 8% revenue growth for record quarterly revenue just shy of $4 billion. EBITDA margin was an outstanding 11.4% and we grew non-GAAP diluted EPS at 9% year-over-year. Operating cash was also well ahead of plan. This means we delivered full year results that were above the high end of the guidance we set last quarter. For the full year revenue growth was 7%. Non-GAAP diluted EPS growth was 11% and operating cash flow growth was 17%. Consistent with my previous commitment to you about disciplined cash management, we repurchased more than $200 million worth of shares in the fourth quarter of 2023. I continue to be very impressed by the people and sound business engine we have here at Leidos and I believe our top and bottom line financial performance over the last three quarters of 2023 just begins to hint at our full potential. Even while affecting our recent organizational realignment, the team ran through the tape to deliver an impressive 2023. I want to thank my leadership team and our 47,000 people who made these results possible through their hard work and dedication to both Leidos and our customers’ missions. This brings me to my second point, the progress we've made towards building a better future. We're already working well in our new capability focused organization and seeing the first fruits from these changes. For example we're sharing best practices much better across digital modernization programs for greater efficiency and efficacy. In Commercial & International, we're quickly redeveloping our growth playbook, especially internationally, which we'll use to extend several of our business lines outside the United States. And we're aggregating and better leveraging our robust engineering talent across our platform businesses within Defense Systems. As we go through this year, we'll see many more ways this new organizational structure unlocks value. Chris will describe a few of the tangible financial benefits of this realignment on which we already have line of sight. But the team and I are acting quickly on two additional critical components to building for our future, reinvigorating our business capture prowess and ensuring we remain the best employer of top talent in the market. On the business capture front, we finished the year with a solid book-to-bill ratio of 1.1 times. As we focus on building quality backlog over time, this gives us a Healthy $37 billion backlog, $8.8 billion of which is funded. Still, I believe Leidos has another gear in terms of business capture. And my new chief growth officer has stepped up to his new responsibilities in this regard with vigor. He shares my passion for winning, and we are committed to delivering industry-leading win rates and above market organic growth. My Chief Technology Officer is aggressively focusing our total IRAD expenditures in select areas to ensure we always have differentiated solutions for our customers. And my HR lead is undertaking an intense effort to rebuild our entire employee value proposition, so we remain the best employer in the market for the best talent. Cindy Gruensfelder joins Leidos to lead our Defense System Sector. She brings extensive Aerospace and Defense leadership expertise and is excited to take this part of our portfolio to the next level. And Dan Antle will rejoin Leidos as General Counsel in April. So he will be able to hit the ground sprinting with us. As a result of these and other changes I've made, 75% of my ELT is now new in new positions or have newly enhanced in more focused areas of responsibilities. The momentum is building having the right people in the right positions, rightly aligned. Not only is this team rightly aligned to the jobs they now perform, but I've recommended and the board has approved fundamental changes to our incentive compensation plans. This means our incentives are much better aligned to our shareholders and customers' interests. These changes are fully laid out in our upcoming proxy statement, but big picture, you'll see simpler metrics around revenue, profit and cash with increased emphasis on margin, while retaining a heavy focus on relative TSR performance. This brings me to my third point, expectations for 2024. Chris will provide specifics on our 2024 financial commitments in a few minutes. Notably, our guidance fulfills the three-year commitments that were articulated on our previous Investor Day. We've already exceeded the margin target that we set in 2021, and this level serves as a great foundation from which to grow in the future. Our three-year cash conversion results ought to be right at, at 100% target, which is the right level of performance for our business. And we have clear line of sight to our three-year revenue growth target. While it is important to me that we meet our prior commitments to you, I expect us to do better going forward. Our financial performance should be at or near the top of the industry. And to bring this improved profitable growth trajectory to life, 2024 will include deep strategic analysis within Leidos. Let me summarize this strategy process for you. Each new sector president will bring forward a best-in-class three-to-five year growth and profitability plan for their markets in a today-forward view. And our growth and technology organizations will work together to create a proprietary hypothesis of the future, a future back look at customer challenges and needs for 2033 and 2028. We'll synthesize these today forward and future back views to identify market gaps and growth opportunities, and choosing among them will enable us to crystallize our new North Star. This process is being engineered to position Leidos to lead the industry in revenue, profit, and cash growth, and we look forward to sharing our plan with you at our next full Investor Day, likely early next year. In the meantime, this year, we'll look forward to opportunities to showcase for you many of the differentiated technology solutions, what I call Golden Bolts, we already use and are creating to solve our customers' most vexing problems. Finally, you may have already noticed the launch of a new branding campaign for Leidos this year, Making Smart Smarter. While we've gained important name recognition over our first 10 years, this campaign is about capturing brand recognition for Leidos. As you can see in the example on slide five, Making Smart Smarter is centered around our people. How they and the breakthrough technologies they create in a unique ecosystem with our partners and customers truly set Leidos apart from everyone else. With these three simple words, we'll tell the story of the collective intelligence that is uniquely Leidos. Our campaign will catapult understanding of what Leidos does differently and better than anyone else, and also serve as a beacon for present and future, best of the best employees. In closing, with a growing Promises Made, Promises Kept culture at Leidos, we've put many of the commitments I've made to you over the past nine months in the done category. We've exceeded our 2023 financial commitments. We've enhanced our focus on cost controls and cash generation. We've taken down leverage substantially. We've allocated more capital to shareholders, and we've moved expeditiously to a leaner, more focused organizational structure. By delivering on our 2024 plan, we'll soon put our full 2022 to 2024 Investor Day commitments in the done category also. But we are far from done. We have a busy and productive year ahead of us at Leidos. We will continue to drive toward great full profitable growth, not just revenue growth. We will aggregate our efforts toward better customer outcomes and better business pursuits. And the new leadership team and I will be working every day to make Leidos not just successful, but awesome in every way for every stakeholder. With that, I'll turn the call over to Chris for more details on our 2023 results and our 2024 outlook. Chris.

Operator:

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Jason Gursky with Citi. Your line is open.

Tom Bell:

Thanks, Jason. Tom here. I'll go first and then ask Chris to chime in. Macro picture, as Chris articulated, our ‘24 guidance is somewhat conservative given the funding uncertainties on Capitol Hill. So we're not leaning forward assuming that there's growth in the Defense budget this year. It all depends what Congress decides to do in the coming weeks and months. But longer term, sadly, the world is not becoming a safer place, and we don't see that customers are going to be spending less on National Security and Defense. So generally speaking, we see a 3% to 4% increase in Defense budgets over time. But we're going to model all of that as we go through this year of deep strategic analysis in ’24, to make sure that our assumptions going from ‘25 through ‘28 are in keeping with what the budget assumption is from the Pentagon and other Intel agencies in the U.S. Chris, anything you'd like to add?

Jason Gursky:

Okay, great. I'll leave it at one, so the others can get in and ask some questions. Thanks gentlemen.

Chris Cage:

Thanks, Jason.

Ken Herbert:

Yeah, hey. Good morning, Tom and Chris. How are you?

Chris Cage:

Good morning, Ken.

Tom Bell:

Thanks, Ken. I'll start and then hand it over to Chris. We are so proud of Liz and the Health team for their performance, their sustained performance that you call out over time. And, it is important to recognize that that's a unique mix of unique customer understanding that we feel we have and then unparalleled service to our veterans and others that we serve through the deployment of technology and artificial intelligence in the solutions that allow us to have more throughput for our customers, so that our customers can be served faster. Obviously, 13% revenue growth for the year is based on excellent program execution and profitability and passing the $3 billion threshold for that business is huge, if you don't mind me saying. So we're very proud of Liz and the team, macro, and we see that continuing in ‘24. Chris?

Ken Herbert:

Great. Thank you very much. I'll keep it there.

Operator:

One moment for our next question. Our next question comes from Sheila Kahyaoglu with Jefferies. Your line is open.

Chris Cage:

Sure. Yeah, absolutely, Sheila. Thank you. So, the National Security and Digital Segment combines a couple pieces of our business, one of which is our new digital modernization sector, and that's the one that we see a lot of uplift over time. Steve Hull and the team have already highly energized around bringing together some commonality that we've been using to serve multiple customers and bringing those into repeatable solutions. And so we're often running there and really looking at how we get that leverage from a combined bench, a combined workforce and investing class tools and repeatable solutions. So we see that opportunity. And then, of course, within the core, National Security work we do with our Intel customers, that has been exceptionally well run. And we continue to expect excellent program execution and performance and maximizing our opportunities with that client base as well. But the longer term margin improvement that we see in the near term relates to the gains we can make in digital monetization space.

Sheila Kahyaoglu:

Okay, got it. And then Tom, maybe a big picture for you. You talked about incentive comp changes that'll come out in the proxy. And you highlighted profitability. I think I know why you did that. But where do you think profitability could go just given peers in this business are at the 11% mark at most?

Chris Cage:

Mid-high 10s.

Chris Cage:

Someday Tom.

Chris Cage:

Sheila, I'd only add on, obviously again, as we gave you some color commentary on the new segments, there is a lot of gas in the tank that we see on Defense Systems and Commercial & International. They'll step up in margins in ’24, but that could be a multi-year runway for those pieces of the business and so we've been on this journey for a period of time now. Tom's come in and accelerated that journey, and I think we're seeing what the team's capable of. So excited about where the margins could go over time.

Operator:

One moment for our next question. Our next question comes from Mariana Perez Mora with Bank of America. Your line is open.

Tom Bell:

Hey, good morning.

Tom Bell:

So she – I'm sorry Mariana, I think you're asking about hypersonics and customer demand for hypersonics and then international. The hypersonics is a good news story. And as Chris alluded to in his comments, we saw a pull in to ‘23 of work we thought was going to be in the first half of 2024 of our customer demand signal for hypersonics. We're in deep dialogue with the customers about how we continue to accelerate that business, because that is a capability that the United States needs to deploy robustly. So again, it's kind of like I answered Sheila, I don't know how high is high, but there is very, very strong demand for the United States to field hypersonic capabilities that are in the world class range and obviously we are in a very good position to be a key component of those hypersonic systems going forward. So, I think you're going to continue to see pull through there and focus. I think on the international side one of the most exciting things we have going for us is the strong footprint we have organically and already, obviously in the United States, but also in the UK and Australia. And there is great customer interest in what Leidos can do around AUKUS, not in Pillar 1. I mean, I have no interest in building nuclear submarines, but I really am interested in helping those customers in what they call Pillar 1 and Pillar 3, which are in the Intel data and digital systems worlds. So very much in our wheeled house for what we do here in the United States and in the UK and Australia, and very much a growth engine for us should be how we leverage AUKUS going forward. Chris, anything you'd like to add?

Mariana Perez Mora:

Thanks so much. And if I may, more of a program related question. Do you have an update on how CHS-6 is trending and how much do you expect the program to contribute into 2024?

Chris Cage:

Yeah, just to add some color and I will stay away from specifics, but obviously this is a program we expect that will build in revenue and profitability over the life of the contract and a long contract like this does have a ramp up period. Tom's right, and we were encouraged by the order activity, some long lead items that will actually contribute to revenue in ‘25 even, but we're rounding it out. The profile is going to depend greatly upon what those particular technical solutions, but we're leveraging our vendor network, we're leveraging AI, we've got a great team. There are some activity that we're not interested in low margin work, so some of the pass through will not show up as revenue for Leidos, but overall you can expect this to be an accretive margin program to Leidos overall and with a ramping revenue profile probably more later in the year.

Operator:

One moment for our next question. Our next question comes from David Strauss with Barclays your line is open.

Tom Bell:

Hey, Josh.

Chris Cage:

Yeah David, let me start and Tom can make some bigger picture and comments. I mean we've talked in the past about Health has been great, but the DHMSM program as an example, we're through the deployment phase essentially and so even though we've won some additional work there with Digital First, there is a step down in volumes on that particular program. There was a National Security Intel program that transitioned away from us earlier last year, so that's a little bit of a headwind. So there's always some puts and takes in the portfolio, but more big picture, we're focused on – there's some budget uncertainty. Customer demand has been very strong in Q3 and Q4 and that led to our performance. But as we look ahead to early parts of the year, a lot of the activity will need to transition into Q3 and Q4. So it all depends upon how quickly get certainty in our budget environment and make sure customer demands remain robust. Tom, anything you'd add to that?

Unidentified Analyst:

Great, thank you.

Louie DiPalma :

Tom, Chris and Stuart, good morning.

Chris Cage:

Good morning.

Tom Bell:

The Gremlins program was a fantastic demonstration of our prowess in aerospace. For those that don't know it, it was a remotely piloted vehicle that was also recaptured and then brought on board another manned aircraft. So a fantastic capability. But at this point, no. No, there's no discussions going on with the customers around that program going forward, although it has spawned other unmanned capabilities that we are talking to customers about, that help inform possible growth aspects for our Defense Systems business.

Tom Bell:

There is certainly a possibility, yes.

Tom Bell:

Thanks. Thanks, Louis. Yes, so the beauty of Pillar 2 of AUKUS is not only our presence in the U.S., the UK and Australia. But the fact that the work that is being done in those countries right now in the area that you referenced, is to a large degree already a place that we're playing in. So the beauty of AUKUS is an incentive for the nations to collaborate. We are very excited about the opportunities that gives us to lower the thresholds of sharing data. And obviously there's also big parts of the AUKUS legislation that lower those trade barriers, lower the ITAR restrictions and allow greater data sharing. So we see it as an open door for us to promulgate Leidos capabilities that hereto for Louis, kind of to your question, have been so piped in one country or the other across all those countries, and allow these great allies to punch above their weight collectively.

Tom Bell:

Thanks, Louis.

Operator:

One moment for our next question. Our next question comes from Peter Arment with Baird. Your line is open.

Tom Bell:

Thank you.

Chris Cage:

Yeah Peter, it's Chris. Let me get started with a little bit of color on DES and then turn it to Tom. I mean. You know again this has been a longer growth story than we originally anticipated, but it's a nice one. The team is performing exceptionally well. We've actually extended from one task order now to five active task orders under the program, and it will be on a growth trajectory over the still the next couple years. ‘24 will be stronger than ‘23 on both the top and bottom line and we've seen good migration on the planning efforts, working closely with the customer, and the DAFA’s to get them ready for more migrations as we progress through 2024. So all I can tell you is it'll be a contributor to growth this year, not as significant as maybe once envisioned, but really looking forward to that growth rate continuing to accelerate later this year and into ‘25.

Peter Arment :

Very much so thanks. Thanks Tom. I appreciate it.

Noah Poponak :

Hi. Good morning everyone.

Chris Cage:

Hey Noah.

Chris Cage:

Yeah Noah. Hey, this is Chris. I'll get started and maybe Tom can talk big picture. So Civil is obviously more than SES, but that kind of is implicit is where you're going. And I really applaud the team for great progress and ‘23 to right the ship, and ultimately revenue and margins were in line with our expectations. So the SES business itself is improving. We were higher on revenues year-over-year, but minimal contribution sequentially from product mix. So as we pivot into ’24, we'll expect the pattern to kind of not be as pronounced as in ’23, but probably lower in the early part of the year, accelerating towards the back half of the year, how we see that rolling out right now. We're not all the way done, but we are you know well down the road on executing all of the turnaround efforts that we put in place and some of the things where we're exiting certain geographies. That's a thoughtful, carefully orchestrated process, right, that takes sometimes many quarters to fully see it through. But I'd say, we're in line with where we had hoped to be at this point in time and I think the business is looking forward to better days ahead.

Noah Poponak :

Okay, great. And then just on Health. You've sort of touched on this, but just the year-over-year comparison will be pretty different in the first half or the back half next year. And then, the exit rate on the margin is a lot different than where you started the year. Any color you can provide on the cadence of the growth rate and the margin through the quarters of the year, not to ask – like they ask quarterly questions, but just seems like we could all be kind of thrown off on versus what you're expecting there.

Noah Poponak :

Okay. Thanks so much.

Operator:

One moment for our next question. Our next question comes from Bert Subin with Stifel. Your line is open.

Tom Bell:

Hey, Bert. Good morning.

Chris Cage:

Yeah Bert, obviously the inflationary environment has been volatile, but it's been improving. And so as we progress into ’24, our outlook in that regard is it's moderated down relative to where we were a year ago. So I'm not worried that we've got an imbalance between our top line and bottom line as it relates to inflationary impacts on the business. We've anticipated a robust merit pool for our labor costs and we understand how those will be passed along to certain customers under our cost reimbursement programs. But our pricing patterns have anticipated this inflationary environment now over the last couple years. So as it relates to protecting the margin, the downside on inflation, I feel good about where we're positioned there. Obviously, on the outlay side, there's always this lag, right, between the budget and the outlay and the timing that it's difficult to project. Certainly it's an area that we could see some things accelerate in the near term, depending upon how we get through March in the budget environment. But right now I'd say that, that's not a significant driver as far as any pent up outlays that we're waiting to have, happen to drive significant growth catalyst for us.

Bert Subin:

Got it. Okay. Thanks, Tom and Chris. Just a follow up on – we've had a lot of questions on the VA side. I guess I'm curious, Tom, as you've gone through sort of this review of the business, how big do you want the clinical business to be? Clearly the VA-MDs have been a pretty material driver of profitability upside, and I'd have to assume the ROIC profile is sort of on the higher end of the company. Are there other meaningful opportunities out there, like not maybe the VA-MDs, but like RHRP and Military Family Counseling and others in the backlog and the pipeline that you think, could make clinical a bigger part of the business longer term?

Bert Subin:

Great. Thank you for the comments.

Operator:

Thank you. Our last question. One moment for our last question. Our last question comes from Matthew Akers with Wells Fargo. Your line is open.

Tom Bell:

Sure. There's actually two parts of that equation, Matthew. One of the things that we're focused very much on with our link being elevated to our CTO office is CRAD [ph]. So making sure that we get customer focused IRAD, which has a two prong benefit. (A), it is doing the things that the customers need done. So that points you in the direction of what is the scratch they want to itch, but also its funded work that we can co-invest in. So we're very focused on targeting CRAD in the areas of technology that are going to differentiate us going forward, and we're very much focused on matching our investment, our IRAD in those focused areas also. Macro picture, obviously Software, Cyber, AI, Maritime Autonomy are four of the top things we're investing in. But again, as part of the strategy process, we're asking each sector to identify the Golden Bolts that will truly differentiate them over the coming three to five years, so as to give them solutions to the customer problems that are emerging over that same period of time. So we have an articulated playbook of focused IRAD. We have an articulated playbook of CRAD that we're going after, but we're also creating organically a poll from the businesses of what would you have me invest in that will differentiate my solutions and my capabilities to solve my customers problems.

Chris Cage:

Yeah, sure Matt. And I mean, it's a nuanced situation, so there's some variables you got to think through. Obviously, looks like it may be retroactive. And so if that were to be the case, and if there is a path forward to recovery, monies that were previously paid in the year, and then we have some state taxes that have to follow suit. If all that lines up, it could be north of $200 million of benefit to Leidos. There'd be a little bit of modest uplift on the effective tax rate. But net-net, it would be a great benefit to the company and add to that additional amount of capital we'd have to consider how we deploy appropriately in the later part of the year. So a little bit over $200 million plus, not having to pay the $60 million that we've got teed up in ‘24. So goodness all around.

Tom Bell:

Thank you.

Stuart Davis :

Thank you, Abigail, for your assistance on this morning's call, and thank you all listening on the line today and this morning for your interest in Leidos. We look forward to updating you again soon. Have a great day.

Operator:

Greetings. Welcome to Leidos’ Third Quarter 2023 Earnings Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note, this conference is being recorded. At this time, I’ll turn the conference over to Stuart Davis, from Investor Relations. Stuart, you may now begin.

Tom Bell:

Thank you, Stuart, and good morning everyone. It's really good to be with you today. I'm pleased to report another strong quarter for Leidos this morning, a quarter of record revenue, earnings, cash flow, bookings, and backlog. Revenue grew 9% year-over-year this quarter, our fastest (indiscernible) two years, and well ahead of the pace implied in our guidance. Customer demand remained robust across all three of our segments, and we are proud of the work that we accomplished with our customers to deliver on important missions. Non-GAAP EPS was up 28% year-over-year, with an adjusted EBITDA margin of 11.5%. Cash management and collections were even stronger. Operating cash flow of $795 million was already in excess of our existing full year guidance of at least $700 million. As a result of this quarter's strong performance and the momentum established in our second quarter, we are raising our 2023 financial guidance across all measures. This quarter's results and our improved outlook were driven by the substantial progress the team has made delivering on our performance initiatives articulated during our last call. First, instituting a promises made, promises kept culture here at Leidos. Second, analyzing and improving acquisition performance. Third, enhancing business development performance and backlog quality. And fourth, sharpening Leidos’ strategy. Let me speak to each of these initiatives in turn. First, we're executing well on creating a promises made, promises kept culture here at Leidos, challenging ourselves to consistently deliver on the expectations we set for ourselves, and ensuring that we're having candid conversations about what is working and what can be improved. We're taking decisive actions to reallocate resources and course correct when needed. The team understands that creating this culture is not a one and done or twice as nice event, but rather a quarter-by-quarter disciplined drumbeat. Second, we're taking definitive actions to enhance performance, drive predictability, and de-risk our Dynetics and security products or SES businesses. In Dynetics, we're in the final stages of business integration across all financial contracts, supply chain, manufacturing, and HR systems. This will result in full proactive management visibility into the business, better business efficiency, and a better employee experience. We've added significant engineering and program management expertise to Dynetics to better serve our customers throughout critical programs of record. The growth outlook for Dynetics is strong in the three priority areas I identified in our last quarter. In hypersonics, we're ramping up production rates, while looking to improve effectiveness and lower costs. In small satellite payloads, we have all four Wide Field of View tracking layer Tranche 0 payloads in orbit. Moreover, we're executing on Tranche 1, and recently submitted and recently submitted our proposal for Tranche 2. In force protection, we're tracking toward government-level development testing of IFPC Enduring Shield in early 2024, and we're making progress on the persistent surveillance needs of the Army and Marine Corps. In SES, we saw improvement in the quarter on revenue and margin, coupled with strong bookings. We bolstered our supply chain resiliency and took costs out of the business to create more predictability. At the same time, consistent with the promises laid out last quarter, the team has critically evaluated the business to identify unprofitable product lines and unfavorable geographies, and we've updated our sales projections to better reflect current customer buying behavior. Based on these candid evaluations and proactive measures to right-size the business, we are taking a non-cash pre-tax charge of $688 million. As previously disclosed, the market has changed since the SD&A acquisition and won't return to pre-pandemic levels as fast as previously expected. As a proof point, the TSA administrator testified to Congress recently that the rollout of CT at the checkpoint would not be completed until 2042 at current funding levels. Broadly, customers are delaying recapitalization decisions and holding onto existing machines longer. With this as a backdrop, the team has moved to right-size the business, discontinue sales of an unprofitable product line, and exit numerous higher-risk, lower-return geographies. We remain committed to the overall security products market where we offer differentiated technology-driven solutions. Security concerns will be just as, if not more pervasive going forward, providing a long-term growth opportunity for Leidos. This includes the regulated aviation and ports and border markets, as well as commercial infrastructure security and loss prevention markets. The definitive actions we have now taken will better position our security business to grow from here in both margins and earnings. We also made progress on our third initiative, delivering exceptional business development performance in the third quarter. $7.9 billion in awards is a new quarterly high watermark for Leidos. Our book-to-bill ratio in the quarter of 2.0 brings our year-to-date and trailing 12-month ratios to 1.2. But more important to me, our $38 billion of backlog is now $4 billion larger than last quarter’s, and supports our growth and margin objectives. This is what I was referring to last quarter when I mentioned growing our total backlog over time with quality wins. Let me touch on a few of those quality wins this quarter, which demonstrate the ways Leidos provides differentiated solutions to meet customer (indiscernible). The largest win was the Army Common Hardware Systems’ sixth generation, known as CHS-6, which is a single-award IDIQ with a potential value of $7.9 billion over 10 years. Through technology, we'll be streamlining and optimizing complex supply chains and transforming logistics to be resilient to supply chain disruptions and cyber risks. Because we offered the army a truly differentiated solution, this award was not protested, and task orders are already beginning to flow. Please note, because of the nature of IDIQ contracts, CHS-6 did not material - did not contribute to our record Q3 bookings and backlog that I mentioned earlier. We also had two large Recompete awards in our Intelligence Group that secure our portfolio for years to come. On a $900 million contract to support and enhance Department of Homeland’s security networks, we'll enable cross-agency intelligence sharing and secure collaboration, while delivering capabilities like quantum resistant cryptography, AI operations, robotic process automation, and classified cloud service integration. On a $700 million contract to provide prototype and technology development support to a longtime customer, we'll identify emerging technologies and develop new tools, techniques, and cyber capabilities to enhance their mission. My final callout is a $125 million contract to defend army weapons systems from cyber electromagnetic activities. This award builds on the R&D and field testing we've been doing for years, and it's another example of Dynetics’ ability to transition from prototypes to fielded capability. You'll notice that cyber is a common theme on each of these wins. Cyberattacks are a persistent, vexing problem for our customers, and Leidos is a top provider of full spectrum capabilities and services. In keeping with our approach of anticipatory technology investment, we continue to focus on addressing the next generation of cyber threats, with emphasis in zero trust, quantum proof encryption, network Defense, and cyber physical systems. We also anticipated the convergence of cyber and AI, what we call cognitive cyber, years ago. We've matured a number of technologies and capabilities in this area into pilots that defend against AI-based cyberattacks. As a key driver of our business development strategy, we'll continue to invest in differentiators in areas of critical importance to our customers. Fourth, we're executing a multi-phase, strategic sharpening under the effort we call Leidos Next, a robust journey to unlock the next level of technological innovation, the next level of execution and performance, and the next level of customer success. The goal of Leidos Next is to create a company with a much clearer and even more inspiring vision, our new North Star. We want to become the best company in the world that's solving a core set of problems for our customers and the best employer in the world, hiring and retaining the most talented people in order to do this. This is the essence of Leidos Next. As an enabler of Leidos Next, we will be simplifying our organizational structure to promote operational excellence, allow for faster decision-making, and more tightly align our business around key technology discriminators. This more focused, capability-oriented structure will better enable us to create clear, differentiated growth strategies for each market we serve, allow for more targeted and efficient investment in the highest areas of potential, and enable repeatable solutions to drive profitable growth. Each new sector has ample room for expansion, while benefiting from the collective strength and scale of our $15 billion company. Beginning in 2024, we’ll operate in five sectors that are focused on specific defined capability sets we bring to our customers. Health and Civil will deliver customer solutions with unique capabilities in the areas of public Health, care coordination, life and environmental sciences, and transportation. National security will combine all our technology-enabled services and mission software capabilities for Defense and intel customers in the area of cyber, logistics, security operations, and decision analytics. Commercial and international will combine our existing SES commercial energy, UK, and Australian businesses. Digital modernization will bring together our IT operations and digital transformation programs. This will allow us to serve all our digital transformation customers with better scale and speed brought about by better repeatability of best-in-class solutions with greater efficiency. And lastly, Defense systems will combine elements of Dynetics and our prior Defense business to develop and produce advanced space, aerial, surface, and subsurface manned and unmanned Defense systems. By streamlining the organization and encouraging decision-making at the appropriate levels, we’ll be more efficient and responsive to market changes and customer needs. I'm also upgrading several existing executive leadership team positions. We'll centralize strategy, business development, marketing, communications, government relations, all in one value stream under a new Chief Growth Officer. As such, we'll rejuvenate our customer-centric business approach. Our new Chief Performance Officer position will spearhead program execution to ensure that we keep our commitments to customers, as well as drive cost efficiencies through world class supply chain management, IT delivery, and real estate portfolio management. Lastly, our Chief Technology Officer will now also lead LinC, the Leidos Innovation Center, adding even more emphasis on (technology) innovation and development, and making a profound organization-wide commitment to discovering, developing, and deploying market-differentiating technology, Golden Bolts. We're placing technology innovation at the forefront of our sharpened Leidos Next North Star strategy. Later this week, we'll announce our sector presidents and those who will serve in these key positions. Finally, as I mentioned on our last call, a key element to our approach going forward will be disciplined resource allocation both internally and externally. Internally, last quarter we acted to refine our investment strategy toward those areas of best overall value to the enterprise. Our BD teams have removed opportunities that do not have a clear path to an acceptable market and are reallocating our resources and realigning our pipeline to better achieve top and bottom-line growth for Leidos. Externally, as promised, our team deployed capital during the third quarter towards debt reduction to reach and slightly surpass our previously announced target leverage ratio of three times gross debt to EBITDA. After reaching this milestone, and with near-term acquisitions not a priority for this business, I recommended, and the Board of Directors approved, the first increase in our dividend in over two years. Shareholders of record on December 15 will receive a dividend of $0.38 a share, a 6% increase over our past dividend. Our strong balance sheet enables us to deploy additional capital to shareholder returns. With a stock price that does not fully capture our earnings and cash generation power, we expect share repurchase to be a primary focus for excess cash in the near term. And as we look to the future, we expect earnings and cash to grow, and remain committed to this disciplined capital management and deployment policy. In closing, we're building momentum with two successful quarters as we work toward ending 2023 in a position of strength. Our Q3 results speak to our ability to focus, grow the business, grow earnings, and generate robust cash conversion. I'm very excited about our new organizational alignment for 2024, our new North Star coming into focus, and indications of the full potential of this business becoming evident. With that, I'll turn the call over to Chris for more detail on our financial performance and updated outlook.

Operator:

[Operator Instructions]. Our first question comes from the line of Matt Akers with Wells Fargo. Please proceed with your question.

Chris Cage:

Yes, Matt, thanks for the call and the question. Yes, definitely, the team has continued to make steady progress over the course of the last few quarters, and Charleston is really important to our future strategy. We are on track. It's something that will go live, whether it's late Q1, early Q2. We've launched our hiring campaign. We're working on outfitting the facility. So, that's still tracking to where we want it to be, and we've made other progress as it relates to various supply chain improvements over the course of the quarter. So, again, one of the reasons why the Civil margins trended up this quarter was the SES business showing some signs of improvement, and we're really happy with that progress.

Matt Akers:

Great, thanks. And then I guess as a follow-up, could you touch on kind of the cash flow? I guess the Q4 cash is implied a lot weaker. Is that just kind of timing of the working capital, like you mentioned? Is there anything else kind of one-time in there.

Matt Akers:

Great. Thank you.

Bert Subin:

Hey, good morning, and congrats on the strong quarter. As we think about - hey, Tom, and Chris. This is probably for Chris. As we think about 3Q performance relative to future earnings, were there items in the quarter that you anticipate do not recur outside of the $14 million Health benefit you just mentioned? Your no-shutdown case for earnings in 4Q is expected to be closer to just shy of $1.80, which is still a step-down from 3Q when factoring in that benefit and the tax benefit. So, I'm just curious if there was pull-forward of security products or, something unordinary, or if the business is just performing really well.

Bert Subin:

Yes. Great. Maybe just as a follow-up there, both on the Health and the Defense side, I guess there's three big contracts to think about. There's DES. there's CHS-6, and there's DHMSM. Can you just give us maybe some - a viewpoint on sort of how we should think about those contracts going forward? I know DHMSM was expected to be a headwind. It doesn't seem like that's happened yet. Maybe you're repurposing some of that ceiling value. So, I'm just curious how you think those are going to - those two are going to ramp up and then DHMSM’s going to step down.

Chris Cage:

Yes. Well, I am too, Tom, and I think that this definitely has a horizon, a next horizon to it, Bert. And we've talked about trying to, once the system got deployed, add more capabilities. And to that point, the team was very successful. We won a contract this quarter, not huge, but it's a relatively shorter duration contract digital-first under the DHMSM umbrella. And that is starting on the next phase that Tom was just talking about, taking - digitalizing the information to digitalization and how patient benefits are extended and modernized. And so, that will help moderate the impact of the deployments coming to an end. It is lower in Q4 than it had been earlier this year because of the deployment phases, but we're able to see line of sight to holding kind of at the Q4 level going into 2024, which is excellent. And then quickly on the other two, DES, hey, it's performing as expected and we're seeing some ramp-up consistent with what we said last quarter. A couple of nice task orders are in the hopper right now, multi hundred-million-dollar task orders.

Chris Cage:

That's right. So, it will be a growth catalyst for us in 2024. And then finally CHS-6, Tom highlighted, very proud of the team to prevail without a protest. Won't see any notable activity from that in 2023, but we're positioned for it to be a growth catalyst in 2024. And too early to speculate until we get a little bit more clarity on what those task orders are, but we're rounding out the catalog. Customer seems very motivated to use us to buy as much of the C5 ISR activity as they can to support their mission. So, really excited about getting that one up and running.

Bert Subin:

Super helpful. Thank you, Tom, and Chris.

Mariana Perez Mora:

Good morning, everyone. I have two questions. First one is more like big picture. How should we think about the organizational structure in terms of timing, how long, how much it's going to cost, and how should we think about the cost structure and workforce once this is done?

Chris Cage:

Less is better, but listen, that's not the primary motivation to do this, as Tom talked about. I do see each of these businesses having different objectives as it relates to that. In the example of Defense systems, hey, we have been investing and we will continue to invest more in engineering and technical depth. That is not a cost-driven exercise to get those businesses aligned effectively. But in the case of digital modernization, these repeatable solutions, this automation, obviously, those can lead to more efficient delivery structures, back-office structures, those types of things. So, we're very excited to get to the full potential, and we'll have a lot more to share on that, Mariana, as we get to that next call at Q4.

Chris Cage:

Yes, Mariana, absolutely. This is an area where the customer's always had both incentives and disincentives associated with these contracts. And earlier this year, as the PACT Act volume was ramping up, they modified some of those. And the team has been doing an excellent job not only on throughput, volume, but customer satisfaction, timeliness, et cetera. The customer is motivated to raise the bar yet again because they want to make sure we're continuing to deliver against a high volume of demand. So, we'll continue to recalibrate on what that full potential looks like. But I would just say that we're excited about the prospect of those incentives continuing to contribute, not only in the fourth quarter, but as we look ahead in 2024.

Mariana Perez Mora:

Thanks so much.

Cai von Rumohr:

Yes, terrific. Thank you very much. Great results, guys. To maybe follow up on Mariana's question, so if we take out the $14 million COVID, which was kind of prior period, you did $18.6 million, which is terrific in Health. Could you quantify how big were the incentive accords in that quarter? And give us some sense if they've tightened it up. I mean, are they going to tighten it so those margins go down? Because I think at one point, you were hoping to do mid-teens. It now looks like you're doing $18.5 million, $18.6 million this quarter. So, where's that likely to go? And what impact do you see from potential government shutdown, because you mentioned that as a potential issue going forward.

Tom Bell:

But again, just to foot-stomp at a little bit, Cai, as Chris mentioned in his comments, the risk of a full 45-day shutdown is included in the lower end of our guidance. So, consistent with promises made, promises kept, given the risk of a full 45-day shutdown is possible, the guidance incorporates that risk.

Cai von Rumohr:

So, just to be clear, as a follow-up, the $100 million and the $10 million to $15 million in OI, that is for Health or that is across the company?

Tom Bell:

Veterans is an essential service.

Cai von Rumohr:

Okay. Thank you very much.

Sheila Kahyaoglu:

Good morning, guys. Thank you for the time. So, I wanted to ask about Dynetics and just how comfortable you guys feel with the development programs there, and what sort of hurdles you're looking to get through to sort of get through the development stage into production on those.

Chris Cage:

Yes, Sheila, I mean, obviously, it's a high priority item. We're putting all the right resources on it and very excited about the long-term prospects there. In any event, Dynetics will be a growing business for us in 2024. The higher, steeper ramp, the inflection point on related to IFPC moving to fuller volumes could be later in the year, could trend to 2025. But all signs point to that continuing to be the capability the Army's focused on deploying.

Tom Bell:

Well, you're right, Sheila. What I am doing as we talk about the pipeline for business development opportunities across all the businesses is, we're adding the criteria of, well, what is the expected margin? And that's why in my comment, I talked about not only the increase in the backlog, but that increase supporting our margin and cash expectations for Leidos. So, you could assume that the general health of the pipeline has increased in - has been accretive in the margin potential, and is very much on track with helping us stay a very profitable, cash-accretive business in the future.

Operator:

Our next question comes from the line of Tobey Sommer with Truist. Please proceed with your questions.

Tom Bell:

Sure. I mean, it's not really rocket science. It's simply looking at the pipeline, Jack, and making sure that where we are spending the talents of our people are on the opportunities with the highest P win and the highest benefit to Leidos. It was that each business area in Leidos was given a general growth target, which was generally the same for each businesses, and that's not my philosophy. My philosophy is, we're running one company called Leidos. We're trying to grow the topline and bottom line of Leidos. And as opportunities ebb and flow between the five businesses that we have today, or the five businesses that we'll have in 2024, the key is that we aggregate business development resources and talent to those areas that are going to have the biggest bang for the buck. And so, that's really all it is. Instead of trading resources chasing low margin work, because each business was incentivized to grow no matter what, I am interested in growing Leidos as a whole. And sometimes that means some businesses will grow disproportionately to others. Chris kind of touched on this a little bit. In the future, not all five businesses for Leidos will have the same topline and bottom-line goals. I'll be measuring those and putting them out there for the team, commensurate with the market that they're in, the potential of that market, and the competitions and the opportunities that present themselves in that market for the next year, two years, three years, four years. And that's the whole philosophy of redeploying the business development time and talent to those areas of greatest return for Leidos, therefore, our customers, and by extension our shareholders.

Operator:

Our next question comes from the line of Seth Seifman with J.P. Morgan. Please proceed with your question.

Tom Bell:

Yes, thank you, Seth. Great question, and you're right. I'm not going to get to specifics because frankly, we don't have them yet, but I have hypotheses. And so, the hypotheses is, if you look at the five businesses, some of them are positioned for topline growth because of customer demand and interest in solutions that they can provide. Other businesses, we're going to be calling them sectors going forward, they are more and aggregation of programs so as to bring better bottom-line results. My hope is that in time, each business over time, over five, six years, topline growth and bottom-line growth may be countercyclical in businesses, but that doesn't mean I ever think any business is not also a topline growth story, and also a bottom-line growth story. So, we'll be using 2024 to have a very purposeful strategic planning exercise around, what is the full potential of each business? Where are they in the customer's ecosystem? How does the customer's buying behaviors, how do we predict they'll unfold in the coming year? And therefore, what are the goals and objectives for that business in the near term and the long term? And business development resources, technology resources, will be deployed according to those plans. It's simply going to be, the money is going to follow the plans that have survived the scrutiny of the strategic planning process, and therefore have the most merit for investment of our capital. That's it in a nutshell. And as Chris suggested, we're excited about 2024 and going through that strategic planning process and sharing more results with you over time as those come to fruition.

Chris Cage:

Yes, I mean, big picture, Seth, I think you're thinking of it right. We hit our leverage target. We're happy with where we are. The interest rate environment could be vastly different in 2025. So, that's something we'll pay close attention to, but I think you've got it right. We've got a dividend program. Tom just talked about an increase that uses a little over $200 million a year of cash, a CapEx program at around 1% to 1.5% of revenue. And then we've got a lot of excess cash that we’ll generate, not only in the fourth quarter, but next year. Delevering further at this time is not a priority, but it's always something we'll evaluate relative to the interest rate environment much.

Seth Seifman:

Thank you.

Louie DiPalma:

Tom, Chris, and Stuart, good morning. Within healthcare, you referenced how DHMSM could be stable going into 2024. How should we think about the VA healthcare exam volumes going forward with the tailwind of the PACT Act? And has there been any changes in the competitive dynamic there?

Louie DiPalma:

Excellent. Thanks.

Operator:

Sure, no problem. And our last question comes from the line of Ken Herbert with RBC Capital Markets. Please proceed with your question.

Tom Bell:

Yes, well, I can't put a number on it because we're only now at the point where we can start to imagine the opportunities that are in front of us. But I'll call your attention to the three functional leaders that I talked about enhancing their positions. First and foremost, the Chief Technology Officer. Bringing LinC into our Chief Technology officer is going to help us become more efficient and more effective at creating and deploying technologies for the benefit of all of our businesses. I am really excited about focusing our R&D pipeline on those areas of technology that will propel our current business, enable us to compete and win and insert technology in those businesses, and win new businesses going forward. So, I think there's great opportunity for us in the CTO office. In the CPO office, the Chief Performance Officer, that is the internal wheelhouse of everything that makes Leidos an efficient, effective corporation. I mentioned real estate, procurement, IT, program management, are all going to be in that. The new leader of our Chief Performance Officer will have the responsibility to not only make sure we are best-in-class when it comes to the quality of the product we put on the field to make Leidos as effective as possible, but I'll also be asking that individual to ensure we are world class as a cost of doing business at the corporate level. And then last but not least, aggregating the complete value stream of growth, strategy, sales, marketing, communications, government relations, all in the Chief Growth Officer, will put us in a prime position to ensure we have unparalleled customer understanding for where the customer's going and how we're going to skate to the puck of where it's going to be, as opposed to just chasing RFPs. So, the net sum of all of that, Ken, I believe will make us a more efficient and effective corporation. But again, as Chris said, it’s not - this isn't a cost-cutting exercise, this realignment. This is aggregate the capabilities of Leidos in a better way to make us more effective and efficient.

Ken Herbert:

Great. I'll leave it there. Thanks for the color and nice quarter.

Stuart Davis:

Well, thank you, Shamali, for your assistance on this morning's call, and thank you all for your interest in Leidos this morning. We look forward to updating you again soon. Have a great day.

Operator:

Greetings. Welcome to Leidos’ Second Quarter 2023 Earnings Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note, this conference is being recorded. At this time, I’ll turn the conference over to Stuart Davis, from Investor Relations. Sir, you may now begin.

Tom Bell:

Thank you, Stuart, and good morning, everyone. I'm pleased to be with you today leading Leidos into our exciting second decade. I'm also very happy to report that we closed a strong Q2. Driven by a healthy demand environment, we achieved revenue growth of 7% year-over-year, with strong organic growth across all segments. Margins, earnings, and cashflow rebounded from our first quarter, driven by, an improving business mix, a partial recovery in the security products business, and a series of fast-acting initiatives implemented across the business focused on costs and collections. Adjusted EBITDA margin of 10.9% was up 150 basis points from Q1, and non-GAAP diluted earnings per share of $1.80 was up 22% sequentially. Also, operating cashflow of $164 million was up $262 million from last quarter. While putting this quality quarter on the books speaks to the underlying strength of the business, even more important to me, it reflects ability of the Leidos team to focus and deliver when expectations are clear. Now, as this is my first quarterly call with you, I thought I'd share some of my initial observations of Leidos. Over these first months, I've met with customers, employees, and analysts, and I've conducted detailed operating and strategic reviews with all our business groups and each of our functional organizations. The headline from this work so far is clear, our business foundations are impressive. I've come to think of these foundations in three distinct pillars. One, an incredible team, two, compelling technology creation, and three, the ability to act with pace while leveraging scale. These three elements in combination enable us to uniquely solve our customers’ most vexing problems in differentiated ways. Let me unpack that a bit. First, we're a company of exceptionally talented and dedicated individuals. Their breadth and depth of expertise is remarkable, and they are palpably connected to our customers’ missions. That translates into a truly differentiated culture with deep customer insights. Also, the esprit de corps and genuine care for each other at Leidos, creates an environment that embraces collaboration and entrepreneurship, critical to our continuing success. Our ability to effectively attract and motivate top talent is a distinct competitive advantage for us. And in this regard, Forbes recently named us as one of the best employers for diversity for new graduates and for veterans, and Ethisphere recognized us as one of the world's most ethical companies for the sixth consecutive year. Second, technological innovation at Leidos is impressive, broad, and deep. The advances we are pursuing across Leidos are world-class. We leverage these key technology differentiators, what I refer to as golden bolts, across our entire portfolio. And we deploy these golden bolts in disciplines ranging from secure software to cybersecurity to signal processing, so as to bring extraordinary capabilities to our customers. A couple of recent examples of delivering complex mission capabilities to our customer includes, the successful hypersonic test launch under our MACH-TB program, and the last major deployment wave in the continental US of MHS Genesis, the Military Electronic Health Record System. This was done on time and on schedule, also significantly enhancing system capability. We've also been at the forefront of unlocking the power of artificial intelligence for our customers for decades. We've developed and deployed trusted AI to tackle some of our nation's most challenging missions. Our debut in applied AI was in 2004 when we built a self-driving vehicle as part of DARPA's Grand Challenge. By 2016, we launched the first unmanned autonomous ship. And now, we're deploying next-generation computer vision for automated passenger scanning in our ProVision 2 platform. Also, recently, we've deployed large language models in our Health group, designing a trusted AI solution where humans and AI work as partners to more rapidly align resources and improve our support to beneficiaries. Differentiated technology, including AI, created, unlocked, and responsibly controlled by our amazing people, is and will continue to be a unique attribute of Leidos. Now, to continue to accelerate our technical innovation, we are investing to broaden and deepen our workforce capabilities. So far this year, we've upskilled well over 3,000 of our people in fields ranging from AI to cyber, to software to digital engineering, and it's open to all our employees, not just our technical wizards, so that all can be conversant in our golden bolts. The third pillar I've found here is equally important, scale and agility. Every customer I've met with is feeling the stress about the pace of change. Hard, vexing problems are coming at them at speeds they've never experienced, and they're looking for partners with speed and scale to address these holistic problems. They need us to operate with a clock speed that matches their urgency. At Leidos, we lean into this environment by challenging ourselves to operate with a strong bias for velocity. For example, within the US Space Force, the Space Development Agency is focused on rapid delivery of space-based capabilities to the joint war fighter. This is an ideal fit for Leidos, an essential, technically challenging mission where standard procurement cycles aren't acceptable. To that end, today, our satellite payload remains the only Tranche 0 tracking layer asset in space, and we're on track to launch Tranche 1 assets soon that will serve as the foundation for the defense of our nation from hypersonic missiles. All these findings have strengthened my conviction in the potential of Leidos. However, also in my first months, I've identified some areas where we must improve. First, some recent acquisitions have fallen short of plan. While I believe those acquisitions offer us significant strategic benefits, we will redouble our efforts to achieve the value envisioned in our acquisition business cases. Second, all on this call recognize the fact that our financial performance has not always lived up to our investors' expectations. The team and I have had a series of candid conversations in this regard, and as a result, we have agreed that together when we make a commitment whether to each other, our customers or the Street, Leidos will meet that commitment. I call this simply a promises made, promises kept philosophy. Third, recent business development metrics have not been up to par. While we have a healthy backlog, currently $34 billion built over the last five years via a book-to-bill ratio of 1.3 times, we can and must do better. I believe that for a business like us, total backlog is a more relevant measure of future revenue growth than quarterly book-to-bill ratios. We will be determined to grow our total backlog over time with quality wins. As such, we'll be candid with ourselves about where we have a differentiated capability that the market recognizes and resource it appropriately. And where perhaps we find we do not enjoy true differentiation, we will ask ourselves some honest probing questions, courageously acting on their answers. Finally, I believe Leidos can benefit from a certain strategic sharpening. To propel this and to optimize our success going forward, we are now in the process of crafting a clear new north star for Leidos. As we crystallize this new north star, we will use it to guide all our strategic decisions, and over time, this will improve our win rates, drive margin enhancement, and better enable us to most successfully serve our customers’ most important needs. While this north star is currently a work in progress, I can give you a few initial indications of where we'll be going. We'll take steps to simplify our organizational structure to promote operational excellence, allow for faster decision-making, and more tightly align our business across our key technology differentiators. We will focus more on the bottom line via greater cost discipline and by refining our investment strategy toward those areas of best opportunity, best overall value to the enterprise. And we'll be very thoughtful and disciplined on capital allocation, both internally and externally. In the near term, I will be laser focused on improving execution, so I don't expect much in the way of additional inorganic growth, but after we complete our next strategic plan and reach our targeted leverage ratio, select M&A will likely make sense for us again. At that time though, we'll be crisp in our approach to ensure there is a clear opportunity to create value for Leidos and our investors. Lastly, I believe that a regular and predictable program to return capital to shareholders drives better investment decisions across any enterprise, so be looking forward to that as well. As we progress this work, I'll look forward to updating you on how we plan to accelerate growth here at Leidos, especially on earnings and cash. Now to our 2023 guidance. Based on our strong Q2 and our revenue momentum halfway through 2023, we are raising the top and bottom of our revenue guidance to a new range of $14.9 billion to $15.2 billion, an increase of $150 million at the midpoint. Revenue growth has been a key feature for Leidos in the recent past, and I'm pleased to acknowledge that this element of our business will continue to deliver for us. The delta in margin performance between the first 2Quarters of 2023 indicates to me variability in profit margin greater than that suggested by the prior 20 basis point guidance range Today, this is primarily due to the variability in our security products business. Now, the good news here is that the Civil team is aggressively knocking down these challenges by leaning out the cost structure and strengthening the supply chain. But considering the practicalities of a company becoming slightly more tied to product delivery timing, we are widening our adjusted EBITDA margin range guidance to 40 basis points. Therefore, our revised EBITDA range will be 10.1% to 10.5% for 2023. Lastly, we're reaffirming our non-GAAP diluted EPS range of $6.40 to $6.80, and we're reaffirming our operating cashflow target of at least $700 million. In closing, I'm optimistic about our future as we set course for Leidos’ second decade of growth, and I look forward to meeting with you at upcoming conferences and roadshows. With that, I'll turn the call over to Chris for more detail on our financial performance and updated outlook. Chris.

Operator:

[Operator Instructions]. And our first question is from the line of Bert Subin, Stifel. Please proceed with your questions.

Tom Bell:

Yes, thanks Bert. Well, first, before I turn it over to Chris to give some specificity on the latter part of your questions, let me say how proud I am of Jim and the team as they've been driving progress against that recovery plan. One of the first meetings I had with Jim was about the recovery plan and how we were going to get that ship righted. And as Chris said, the guidance that we've articulated incorporates the range of likely outcomes. The market is improving, as Chris suggested, with the Leeds award. We believe we have a superior product offering. We believe the customer continues to show confidence in our solutions, and the team is out there aggressively prosecuting the market. So, we feel very good about the fundamentals internally and the market externally. And also, the team is very focused on expanding the market that we serve with less traditional security solutions that are needed by a different set of customer sets. Chris, anything you'd like to add?

Bert Subin:

Great. That's super helpful. Thanks. And just as a follow-up, Tom, so Leidos has been talking about a Dynetics inflection being on the horizon for a little while now, and previously the expectation was organic growth was going to ramp pretty materially in 2024 for that business. As you've come into Leidos over the last three months and got a greater assessment of sort of where things are going, can you just walk us through how you're thinking about Dynetics and what you see as the growth path there.

Chris Cage:

Bert, the only thing I'd add there is, I mean, Tom's right, our agility and expertise gets us in the door. Our frontend Leidos Innovation Center, we call it LInC, with some of the brightest minds in some of these areas in the world, have us access to the most important customer sets. So, we have to perform. That gets us in the door. The team has to perform and deliver, and that's what I'm most encouraged by seeing progress that they're making on having improved discipline on bidding and execution, improved supply chain management, all those things that are critical as we ramp some of these programs up towards low-rate production and full-rate production.

Operator:

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

Tom Bell:

Yes. Thanks for that, Peter. Yes, so I think having some diversity in our portfolio really makes sense for Leidos. I mean, after all, we're a $15 billion company, and in order to have countercyclical capabilities, you have to have some exposure, both to services and products. So, I like the fact that we're in a products business also. And I also like that there is connective tissue in everything we currently do that is poised in that thing I talk a lot about around how we solve our customers’ most vexing emerging problems. So, whether it be products or services or software, it's really focused on how we lean into our customers’ biggest challenge. I'm coming to understand our specific products and how they mix in with our services business models and how that makes sense. And at the core, whether it be a product or a service, remember that everything we do these days is at its core, IT services and algorithms and software and cyber, something that we are absolutely world class in. So, I like the mix and I think we'll be continuing the mix, and at the same time, we'll be very purposeful in how we exploit our advantages in each of those sides of the business.

Chris Cage:

Yes, thanks, Peter. I mean, first of all, obviously the team here wants to deliver against the original commitment, but the wider range was prudent, given where we are and the volatility you'd seen in the first half of the year. But I’m very encouraged about the second half and very optimistic about how we'll progress from here. I would point to a couple of things. Security products is an element of that, and as I said in my prepared remarks, we have the potential to have a significantly stronger second half there. We've laid a lot of good groundwork to realize that. Not everything is within our control. On top of that, there are a couple other things. In Health, we had a great quarter in Health and the team has done an excellent job, and there is the opportunity to sustain that momentum as we move forward. But some of that is dependent upon not only our performance, but throughput and customer satisfaction, some variables on incentives that, again, we'll monitor closely, and our past performance suggests that those are fully attainable. So that's another variable that we wanted to give ourselves some capacity for because that incentive calculations is somewhat new. And then lastly, just some of our digital monetization programs continue to ramp up and we're very pleased with the performance the team has executed against there. And there are some opportunities for more project work in the back half of the year. And depending upon how and when that comes to pass, could push us towards the higher end of that range.

Operator:

Our next question is coming from the line of Matt Akers with Wells Fargo. Please proceed with your questions.

Chris Cage:

Hey, thanks, Matt. Yes, obviously, we're super pleased with the performance there. 9.3% OI margin, the highest in five years, and a lot of that's led by progress we've seen on some of our big digital monetization programs. And the team's done an excellent job there with NGEN, and DES is continuing to ramp, and there are others. And there are some other things going on that are sustainable outside of that, maturing development programs. Tom talked about Wide Field of View, especially Tranche 1, incorporating the lessons learned from Tranche 0, better mix overall with the Australian airborne aviation business that we acquired last year. That's helping us. And then there are some variable items, and I wouldn't say these are totally one-off, but we need to continue to perform well to realize these in the future. Award fee scores were very strong. We reached certain program milestones, and we did close out some old older projects. So, we won't deliver 9.3 every quarter near term, but that's the expectation we're setting for ourselves and the team longer term. And so, one thing that we will not take our eye off the ball on is an underpinning focus on indirect cost management and program execution. So, yes, great progress in the Defense Solutions segment and we're optimistic that there's more of that ahead of us.

Chris Cage:

Yes, it's a great question. Very timely. In fact, we had a review internally with the team yesterday, and we've got a really strong team on DES and working hand in glove with the customer. This year, it's still a modest contributor to the company in the order of $50 million of revenue, but we just walked through a number of active task orders that are either in evaluation by the customer, or some other ones that were coming up for bid and evaluation later this year. So, we're seeing the activity level increase and there's a roadmap on migrations of more users under the DoD net. So, again, continue to think of that as something that will be a much more significant contributor in 2024 and 2025 really beyond that. And we'll have more to say as we get later in the year and have some clarity on when those get determined.

Operator:

The next questions are from the line of Jason Gursky with Citigroup. Please proceed with your questions.

Tom Bell:

Yes, thanks for that. I wasn't here, so I can't say exactly what went “wrong.” I don't know that anything went wrong per se. I'm just looking at the current annual operating plan and the five-year plans for business against the original business case that was put forward to the board to approve the deals. And there's a certain gap. Now, I've been in this industry 40 years. I've frankly never seen an acquisition business case that doesn't have a gap. So, that's not new. That's not novel to Leidos, and that doesn't say that we've made mistakes in the past. That just means we've got the ball now and it's our job to make sure we leverage the investments we've made and the capital we've deployed to ensure that the real cores of the acquisition business case come to pass. That's with focus. That's with resolve. That's obviously by getting deep dives into program executions, and also making sure that we go back to the basics of the original business case and say, what is the golden bolt that we were trying to buy, and how do we make sure we deploy it across the enterprise as effectively as possible? So, that's what I'm focused on playing forward from here. As I suggested in my comments, I think the acquisitions that have been accomplished over the past 7, 8, 9 years here at Leidos, all make sense to me. Now, the key is just doubling down and making sure we make them make sense for our bottom line. Chris?

Tom Bell:

And on the subject of future acquisitions, you asked about what's going to be the drive going forward? As I suggested in my prepared remarks, obviously I think having a regular return of capital to investors makes sense to us. So, we're really focused on executing the work that we have on our plate now before we get back into the market to do M&A. However, when we do, in keeping with the north star that I referenced and a very clear articulation of where we want Leidos to be in 2030 - in 2028 and 2033, which are the two vistas we're setting out for ourselves, we'll have very clear articulations of, what are the technologies that we see emerging, what's the hypothesis of what the customer problems are going to be in the next five, 10 years, how might we either build those capabilities organically or acquire those capabilities inorganically. But all of those will be tempered with a very clear articulation of affordability, hurdle rates, and a very clear strategic narrative. So, premature to actually talk about what those are because we're still working out the north star and the vision of what our customers are going to need us to be, to serve them into the future. But those are the kind of things we'll be talking about.

Tom Bell:

Yes. So, the good news is, I don't think there's a negative market dynamic we're dealing with here. There's positive demand across all of our customers and there's great opportunity for organic growth. As I suggested, we have a strong backlog. We have a strong pipeline, and I think the number is something like $26 billion in pending awards. So, the timing of those awards is unfortunate in that the first half of the year has been light. But again, as I referred to in my comments, I think quarterly book-to-bill ratios can become quite a distraction and are actually quite unhelpful. What I'm focused on is building a quality backlog over time with quality wins that speak to long-term growth for Leidos. And I don't think the BD process here is broken. I know we know how to win. I'm passionate about winning. The whole ELT is passionate about winning and I would not count us out just yet. Chris?

Jason Gursky:

Great. Thank you, guys.

Sheila Kahyaoglu:

Thank you. Good morning, Tom, and Stuart. So, Tom, first one for you, please, and I appreciate your comments in the opening remarks about margin enhancements. What are some of the steps on organizational structure and bottom-line financial discipline you plan to take? Because I was just under the impression that Leidos has pretty good margins, it just could be variable at times. So, where do you see the potential opportunities on the profit margin side outside of the security business?

Chris Cage:

Yes, no, Sheila, I would echo that. I mean, clearly the primary objective here isn't to organize to drive costs out of the business. That'll be a second order variable. And we always try to run lean, so that'll create some opportunity to reinvest. We're hopeful, but back to your question, where are the margin opportunities? Obviously, super pleased with Health moving up a bit from what we had set as an expectation. You see what's possible within the Defense Solutions segment of the business. I think some of that will come down to selectivity. The teams will be more focused on which opportunities they have the ability to earn a quality return on. And so, we’re very optimistic that that'll pay dividends as we move into 2024 and beyond.

Chris Cage:

Yes, thanks, Sheila. So, on the incentive side, again, this was a change that went into effect earlier this year. So, we're working through it and we'll have more to say as we learn more. But I would tell you that the incentive structure at the VBA was optimized from their point of view for all participants in order to better serve the veterans and to deliver better outcomes for VBA. And it gives contractors like Leidos the opportunity to invest, to drive quality outcomes, better throughput, better patient experience, and be recognized and compensated potentially for those outcomes. So, that's just getting started and that creates an opportunity where we're a bit more optimistic that if we perform the way we have in the past, and you have to earn it every quarter that the mid-teens margin has some upside to it that we previously communicated. And we'll just have to see how that goes. Obviously, the caseload volume from the PACT Act is still settling in. And the other thing that's settling in is us earning more than our fair share, if you will, of the work share, because our performance has been so strong. So, some of those variables will impact that as well. But we're optimistic that that should create some sustainable upside. And then on DHMSM, obviously this is a little bit of a headwind on the growth side, and we'll see a bit of a moderation in Q4 and more so in 2024. But from a margin perspective, I mean, it's a quality program, well run, but it is not one of the highest margin programs within the Health portfolio. So, I don't think that's a negative as it relates to Health margin. And the team is working hard and has a number of high-profile opportunities that they're pursuing right now that'll help offset the revenue piece as we move forward. And we talked about RHRP as another example of a program ramping that'll help offset that a little bit too. So, a few dynamics going on there, but don't look at DHMSM as a margin headwind for us.

Sheila Kahyaoglu:

Great. Thank you.

Seth Seifman:

Hey, thanks very much. Good morning and welcome, Tom. I just wanted to follow up. I think there was an earlier question asking about Dynetics and the inflection that was expected there next year. I wonder, maybe zooming out to the whole business, there are some standing three-year targets out there in terms of organic growth that would point to some acceleration in 2024. I guess, Tom, in the spirit of promises made, promises kept, should we should we still consider those targets to be operative?

Chris Cage:

Yes. Seth, the only thing I'd add, obviously, Tom coming on board, we've got to get him even more deep into our detailed plans as we look ahead to 2024. And one of the things that is a change condition is ensuring that we are optimizing for the best bottom line in cash performance and the selectivity that'll come with that. So, really being thoughtful around how our resources get allocated to pursue opportunities in technical investment and differentiation as we pivot into 2024. And some of those things will have near term paybacks and some of those things will have longer term paybacks. So, more to say on 2024 as we progress through the year, but everybody's heads down on delivering this year as strong as we can and putting some wins on the board and positioning for the future.

Operator:

Our next questions are from the line of Robert Spingarn with Melius Research. Please proceed with your question.

Tom Bell:

Yes, you're right, there is a curious dynamic that's been set up as a result of the debt ceiling debate and resolution that occurred, that obviously people on Capitol Hill are expressing optimism that they will solve before we're facing another government shutdown. At the same time, we're actively working with all of our customers on both sides of that equilibrium, if you will, to ensure that if there are things we can do this year to get them out of harm's way of any possible budget challenges they might face next year, we're engaged with them on that. And we're also focusing on exactly what you suggest, Robert, which is expanding the areas where we can help those customers and/or customers like them. So, I’m not overly concerned about 2024 and the law of unintended consequences, if you will. I'm very focused on the fact that the team is engaged with customers about all those eventualities, and we feel we're fairly insulated against near-term impacts from any possible government shutdown. Chris?

Robert Spingarn:

Chris, just on that last part, when we think about healthcare and discretionary versus non-discretionary funding, so Medicare, Medicaid and so on. Is there a way to quantify what portion of your healthcare business gets funded out of those non-discretionary budgets?

Robert Spingarn:

Great. Thanks so much.

Jasper Bibb:

Hey, good morning. This is Jasper Bibb on for Toby. Just wanted to ask about the security products business and underperformance versus the acquisition case there. Would there be any way to quantify what getting that business back up to your targets might mean for Civil segment revenue growth and margins over the next few years?

Tom Bell:

And on the top line and bottom-line expansion of our security business, as I have said, security is a vexing problem that's not going away. And in fact, more and more Civil customers, don't think government, civilian customers, are thinking about the security of their premises and the need for them to be more guarded on what goes in and what comes out. This is a great opportunity for market expansion for the team at very good margins. So, I like our bet on security, and I think it's going to be a good place for us to be as we prosecute the next five years.

Stuart Davis:

Thanks, Josh. Hey, Rob, it looks like we're coming pretty close to the top of the hour, so I think we have time for one more question.

Noah Poponak:

Hi, good morning, everyone. Chris, last quarter with security products, you provided a lot of detail on where the challenges were. You talked about customer schedule delays where they couldn't accept product, supply chain disruption, and then you said there were service agreement penalties and product investments. I was wondering if you could just quickly update each of those. I mean, how many customers are delayed and how many are on schedule? And then I guess those other three, are they just kind of fully behind you or not?

Noah Poponak:

Okay. I guess it's a pretty good step-up in the quarter sequentially, despite not being to the finish line on all of that. And I appreciate the widening of the margin range and the volatility that's inherent in what we're talking about here, but the guidance implies the margin is a decent amount lower in the back half, yet you're describing getting to the finish line on these Civil items. So, does the low end just incorporate the unlikely but can't rule it out risk that that customer delay takes a big step backwards? Or is there something outside of the tail that could get you to the low end of that margin range?

Noah Poponak:

I understand. And if I might just quickly, Tom, appreciate all the color you've given here, and there's a lot of things you're talking about working on. You've had these questions on the financials of the business beyond 2023 and the prior Investor Day-oriented midterm, long-term outlook. How are you thinking about eventually having another Investor Day providing a fresh set of midterm financial goals versus not doing that and just running the business and letting the results speak for themselves?

Noah Poponak:

Okay. Thanks for taking my questions.

Stuart Davis:

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

Operator:

Greetings. Welcome to the Leidos First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note, this conference is being recorded. At this time, I’ll turn the conference over to Stuart Davis, from Investor Relations. Mr. Davis, you may now begin.

Roger Krone:

Thank you, Stuart. And thank you all for joining us this morning. Our first quarter results demonstrate our ability to drive strong organic growth as record revenue performance was consistent with our long-term target. We expect earnings and cash performance to build momentum as we progress through the year and are fully committed to achieving our 2023 guidance. As I step down as CEO, I am confident that Leidos is truly the leader in our industry with unmatched talent, technical depth, and market facing solutions. Our dedicated team is at the forefront of our customers' most challenging missions as we make the world safer, healthier, and more efficient. As usual, I'll touch on our financial performance, capital allocation, business development performance, and people. Number one, our top line financial performance for the quarter was excellent. Record revenues of $3.7 billion were up 6% in total and over 5% organically year-over-year. Our growth is in line with our long term model, and we continue to take share from our competitors. All three of our segments grew led, by Civil and Health, which speaks to the power of our diversified portfolio. Bottom line performance was lower than anticipated, largely driven by delays in security product deliveries and continued investment in the security product offerings. The delays based primarily on supply chain issues and customers site readiness are fundamentally a matter of timing and will be resolved within the year. The strengths that we're seeing across the Leidos portfolio, especially in the Health business, will help to accelerate margin and earnings performance throughout the year. As planned, cash generation was decreased by the cash tax payments for Section 174 expense for 2022 and the final payment on the CARES Act deferral. Absent those unusual items, cash flow from operations was consistent with last year's levels. We remain on track to generate more than $700 million of operating cash flow this year. Which brings me to point number two on capital allocation. Our long term balanced capital deployment strategy has always consisted of being appropriately levered and maintaining our investment grade rating, returning a quarterly dividend to our shareholders, reinvesting for growth, both organically and inorganically, and returning excess cash to shareholders in a tax efficient manner. We've committed to take down our gross leverage ratio to 3 times and we expect to achieve that by the end of the year. In the first quarter, we refinanced and extended our debt to position us to deploy capital in productive ways. We view our strong balance sheet and investment grade rating as a strategic asset in the current market. The cash tax payments and upcoming debt paydown limited our ability to deploy capital in the quarter, but we resolutely believe that our current valuation is not aligned with our fundamental earnings power and cash generation. Therefore, we bought back $25 million of shares through open market repurchases in the first quarter. As we ramp free cash generation in the second half of the year, we'll create flexibility to allocate capital to benefit long term shareholders. Number three, business development. Most importantly, award activity is returning to normal levels after a protracted period marked by procurement delays and obligations under running budget authority. A more active environment bodes well for Leidos with our long history of being able to thrive in a competitive market. In the quarter, we exceeded our gross awards plan and booked a net of $3 billion in awards for a net book-to-bill of 0.8. Total backlog at the end of the quarter stood at $35.1 billion. Of that, $8.3 billion was funded, which is up 17%. You can read about some of the key awards from the quarter in the press release, but we're particularly pleased to see the intelligence community customers making awards again. Maritime continues as a focus item for us and international airport security is beginning to rebound. To ensure that we bring true differentiation to our bids, we continue to invest in strategic technologies that are core to our business. Last quarter, I talked about cyber, zero trust, confidential compute, and generative AI. We also have a rich history of delivering secure software at speed to support critical missions. We protect the software supply chain from development to deployment to operations, delivering software security that goes beyond compliance for customers like the FAA, DoD and DHS. And we're investing in cutting edge emerging quantum technologies focused on applications, such as quantum augmented communications and the transition to quantum resilient cybersecurity. We see tremendous opportunities ahead. We have $30 billion in submits awaiting adjudication, and we expect to submit another $39 billion over the remainder of the year. Based on the successful Tranche 0 launches in April and the rapid Tranche 1 timeline, the Space Development Agency is accelerating the Wide Field of View program, so Tranche 2 should be a 2023 submit. We also expect expanded follow-on bids on our force protection and hypersonics programs this year. In addition, we're pursuing large supply chain modernization efforts for the army and the Veterans Administration, and digital transformation remains a key priority for our customers. And lastly, point number 4, Lighthouse continues to be an attractive destination for talented people. In the first quarter, we hired more than 2,500 people and increased headcount 7% year-over-year. Even more important, voluntary attrition has dropped down to pre pandemic levels. This improved labor position provides potential uplift to our revenue plan. We're benefiting from the improved labor market for technical talent, but we believe our focus on employee engagement and career development is also a major positive factor. Our managers are living their commitments to Leidos Life by putting their employees careers, flexibility and wellbeing first. They are connecting with their teams and taking the time to engage with their employees around building a career. In our recently completed employee engagement survey, we were above external benchmarks across almost all categories, scoring particularly strong on manager relationships, inclusion and diversity, and employee growth and development. If you want to join an inclusive team and build your skills over a fulfilling career, Leidos is a great place to work. Before turning it over to Chris, I'll touch on the current federal budget environment. The US Congress is currently debating President Biden's $6.9 trillion budget request for physical year 2024. The proposed budget includes increases in critical areas that are important to Leidos, such as defense, transportation, Veterans Affairs, NASA, and energy. Last week, House Republicans passed a bill that would raise the debt ceiling and cap discretionary spending. The bill will not pass the Senate, but discussions can now begin in earnest towards resolving the debt ceiling and the government physical year 2024 budget given the enormous challenges that we have as a nation. Finally, I want to speak to the CEO transition. As I look back on my nine years at Leidos, I am proud to say that we have achieved incredible transformation and growth together, almost tripling revenues and establishing ourselves as a premier broad technology provider. Our strong leadership team helped us win numerous large competitor programs in the US and abroad. We completed transformational acquisitions, including integrating Lockheed Martin's Information Systems & Global Solutions business, which enabled us to expand our capabilities and better serve our customers. Our efforts have not gone unnoticed as we have been recognized as a leader in our industry, providing innovative solutions to complex challenges. Our commitment to our employees has been a top priority, and we have fostered a culture of innovation, engagement and inclusion. We have built a team that is passionate about our mission, vision and values, and conveys that commitment to our customers. Throughout the COVID-19 pandemic, we took care of each individual and prioritized safety and wellbeing above all. Our focus on collaboration, innovation, and inclusion has allowed us to create a culture that enables each employee to grow and thrive, driving our success. We have also made a significant impact on our customers and communities. We have transformed logistics for the UK Ministry of Defense, enabling them to rapidly respond to the crisis in Ukraine. We have driven IT innovation throughout government and helped more than 200 utilities across the US build a more resilient, reliable and sustainable electric grid. We have modernized healthcare information management across the Department of Defense on cost and on schedule, and enabled our veterans to get the disability benefits they have earned through their service. And we have worked in our communities to confront opioid addiction and remove stigmas associated with mental health challenges, making a positive difference in the lives of many. The driving force behind our company's prosperity is undoubtably the exceptional talent of our employees and the unwavering strength of our leadership team. Without their incredible contributions, we would not be where we are today. I am confident, with this team in place, Leidos is poised for continued growth in the future. As I transition out of my CEO role, I'm excited to welcome Tom Bell to the position. I have worked with Tom over the past months, and I am convinced he is the right person to lead this company into the future. With a great foundation in place at Leidos, I believe that Tom's tenure will be rewarding for our employees, customers, suppliers, and shareholders. I will end by saying thank you to each of you for your confidence you've showed in me during my tenure. It has been an honor of a lifetime. Thank you.

Operator:

[Operator Instructions]. Now our first question is from the line of Robert Spingarn with Melius Research.

Roger Krone:

Well, shall we look back in history at the period of time around the Snowden leaks. And I'm a believer, at least in general, that history repeats itself. And it made things more difficult. The timeline to get clearances expanded the depth of background investigations, the level of clearance required to do certain jobs where maybe we were on a path for that to be relaxed, maybe like one notch, I suspect it will go the other way. Access to information will be held tighter. First of all, any leak like this is a really bad thing. And it hurts our military, it hurts our country, it hurts our standing in the international community. So I don't really see anything positive, to be quite honest, Rob, coming out of it. There are some companies, not us, that do background investigations, who do polygraphs, we're not in that business. We are a recipient of clearances. And I can't imagine that this is going to make the clearance process any easier. In fact, I suspect it's going to go in the opposite direction. And I cannot believe, my career, 46 years in the business, that after Snowden that we're back here again with his problem, and it's very, very unfortunate.

Roger Krone:

I really do. It's the debt ceiling. We've talked a lot about a CR that could go well into 2024. And so, for people who have program managers, government contracting officials who have authorizations, appropriations and what have you to get a program under contract before we hit the fall season, I think there's a lot of that going on. And by the way, it's a positive thing. I think all the political posturing around the debt ceiling and the budget – I know the President is going to have a sort of a budget summit in the next few days. Hopefully that will lead to something positive. But there is a positive outcome to that, which is we've had some programs that have been in the acquisition process for years and they're starting to get awarded and adjudicated, and that's a positive thing.

Sheila Kahyaoglu:

I want to maybe ask, first, on the supply chain comments you made within Civil and the security business there. I think your nearest peer there, OSI, grew 13% organically and margins went up. So what kind of changes in your business specifically? Seems like you have some investments in Mosaic. And how do we kind of assume that progressive?

Roger Krone:

Sheila, we're doing some other things, we're bringing more production inhouse where we have more control. We're going to stand up a new facility that we're really excited about. We did have some licensing delays in the period that affected some of the maintenance work that we did. And I don't know why in the quarter, everything seemed to hit us. But the good news is, the business is coming back, air travel is coming back, the long term prospect for SES is really, really positive. And we're bullish on the future. I have the privilege of being involved in some other companies outside of Leidos and they have had these supply chain issues, especially around general purpose processors. And you think you have it nailed down, and then it's the $5 chip that gets you and we had some of that in our own business. Very, very low end stuff that we had reliable supplier, and then we ended up being gapped. The business didn't go away. It's in backlog. We'll get our supply chain where it needs to be, and we'll deliver this product in the remaining three quarters of the year.

Chris Cage:

Chris here again. And I would say our expectation is, again, the tail end of this year, last quarter especially, you'll see that begin to tail down, teams working really hard and continue to do exceptionally well. And Rogers prepared remarks, the on-cost and on-schedule can't be overstated. And so, the customer has trust in us and there are additional capabilities we're working to deliver there. But Health is a bigger story than just DHMSM and we're proving that. The SSA work, the pipeline strength, what we're seeing out of the disability exam business, very pleased with how Liz Porter and the team have positioned that business. This quarter, 15.9% margins, got to the levels that we committed to and actually see more upside at this point in time than we had previously expected. So, it's in a good spot. And even to withstand the DHMSM ramp down, the RHRP contract is now active and didn't contribute much of anything in the quarter. So we'll see more meaningful contributions beginning in Q2 from that program. So that's what's going on in Health.

Operator:

Next question is from the line of Peter Arment with Baird.

Chris Cage:

Absolutely something we've been spending a lot of time on internally, making sure that there's a clear path to get there. Look, it's going to take some hard work. It's not the start that we hoped for. But fundamentally, it begins with getting the SES business back on track and the team has a concrete plan. They've implemented a number of action, there's been some reduction in force, there's been a lot of transition there to make sure that businesses, in and of itself, is a strength, not a weakness in the quarters ahead. I've mentioned Health. And again, we're very pleased with what we see there. And looking ahead to the next few quarters with PACT Act cases ramping up, the SSA program continuing to run strong, there's margin uplift that we see there. The Defense business, quite honestly, they had year-over-year margin increase, but it's not where – it hasn't reached its full potential. And the team knows that. And so, from a mix perspective, we see some programs that are coming online or others that are ramping that will absolutely lift some margins across the board. And then, we're going to have to make sure that we run very efficiently on cost management for the rest of the year. We did that last year the back half and showed what we're capable of. So there's a number of things there that are already in flight. And there is a little bit of seasonality in the portfolio too, Peter. There's definitely – as it relates to award fee timing, incentive fee timing, we've looked hard at when those things should come to pass and when they get recognized. So it'd be a combination of SES getting returned to the right level of profitability, strength in Health and some program mix in Defense and then some cost control actions.

Peter Arment:

If I can just sneak one in. Roger, can you give us the latest update on the Cobham business, how that is going and just any thoughts there?

Peter Arment:

The business you acquired in Australia, Cobham.

Operator:

Our next questions are from the line of Matt Akers with Wells Fargo.

Roger Krone:

Of course, we want to grow. We've got a long term target out there. You can back out of our long term targets, then our book-to-bill has to be greater than 1. And where we sit today, we fully expect our book-to-bill to be greater than 1. But that means, and you all know this, is that we have to win some programs between now and the end of the year. There are some big programs yet to be awarded. We have done well in winning large programs. We don't win them all unfortunately. We never put a bid in that we don't expect to win, but it's a very, very competitive environment and we have to do better in second, third and fourth quarter that we've done. I don't expect, even with the machinations around the debt ceiling and the budget, for the award process to slow down this year. I think it could get a little rocky in 2024 as we get into presidential politics, if we're in a full year CR, trying to get new starts started in 2024. If we don't get an omnibus, I'd like to think we do get an omnibus, but time will tell. We're pretty active. As I said, we still have a lot of proposals to write this year, some of those might actually get awarded this year. We have a ton, well, I guess $30 billion, maybe more than a ton of awards that need to be adjudicated. And many, many of those are going to happen this year. So we're very optimistic about the future, our track record of winning big awards, and we don't talk a lot – actually, our track record of winning small awards is even better than our track record of winning big awards. And that has to do with our customer intimacy and our great program leadership working with our customers, and I feel really good. Something we haven't talked a lot about what we call on contract growth, but our ability to expand our business base with the existing customers, that has always been very strong for us. So I'm optimistic. And Tom Bell, he's got a strong business development background. He's sold globally around the world. He has built a terrific business at Rolls Royce, and he's going to lead the business development effort here. And he'll probably do a much better job than I did of winning programs. So I'm really optimistic about the future.

Chris Cage:

Matt, we usually don't give a lot of details quarter by quarter, but I would tell you that we'll build. Clearly, the SES turnaround, the actions that are taken and underway, they're not going to deliver its full potential overnight. So I would expect Q2 to be better, but Q3 and Q4 to be better still. And I think you should expect we'll be gaining a lot of steam into the summer. We'll get Tom fully on board as he'll have a point of view. And he'll want to be aggressive. I expect that fully to make sure we're delivering on our commitments as we all do. So my expectation is Q2 will definitely be better, but you'll see our full potential in the back half of the year.

Bert Subin:

Maybe just to sort of switch gears a little bit. Where do we stand across Dynetics? You noted the Wide Field of View award. But can you update us on how IFPC and the hypersonic glide body contracts or potential contracts progressing? Do you still expect that we'll see a material inflection in that part of the business next year?

Bert Subin:

Maybe just a follow-up question within the Defense side. Last quarter, you highlighted that customers wanted to move a little faster on DES and you were just sort of balancing that against providing sort of the highest quality service you could. Can you update us on where transitions stand and whether your view of the ramp process of that contract has changed at all?

Operator:

Our next question is from the line of Seth Seifman with J.P. Morgan.

Roger Krone:

Seth, I'll start and I'll let Chris add. We always like to talk about our portfolio. And if we have a situation like an SES where the first quarter is a little slow and we look at the full year, we're always looking at other parts of the portfolio that have the potential to outperform. And where we stand today, we're optimistic about both top line and bottom line in health. PACT Act exams in general, our ability to hit our service level agreements and in the future earn incentives based upon performance. So we feel we feel good about that. I talked at some length about the DHMSM program. The other two programs, what we call, military family life and counseling, and there were reserve health readiness programs are both doing extremely well. And RHRP, we're finally starting to do events with guards people and reservists which will drive top line. But I really want to give kind of hats off to the whole Health team. They have done just an outstanding job of executing on their program, staying close to the customer, providing a value added benefit. And when you do that, then good things happen in the group. And customers come back, they want to do more, they want to do expanded work. And PACT Act is a positive influence in the future. But in the disability exam business, you get more than your fair share because you hit your service level agreements with both timeliness and quality of the exams that you do. And our organization at QTC has always been at the forefront of performing in the exam business. And it just gives us confidence and optimism that, overall, we may see some better performance in Health than we had initially thought. And as we look at our guidance in the balance of the portfolio, when we were behind in one business, we're always looking to where we think we will overachieve and Health is certainly that area this year.

Seth Seifman:

Maybe if I could follow up on that, Chris, just to put a little more fine point on it. If I annualize Q1, it's basically implying that that the Health earnings are going to be flat in 2023 versus 2022, which I think would be a pretty good result, given some of the margin headwinds there. Is that then a sustainable level of earnings going forward, given the maybe above trend margin that we're going to see in 2023 and some of the DHMSM headwinds? Is it a level off of which the business can grow? Because it's been executing quite well for the last couple years? Or is it a level that you kind of had to run real hard to get there in 2023, and so maybe that's a level that's above what's sustainable?

Operator:

Our next question is from the line of Tobey Sommer with Truist Securities.

Chris Cage:

First of all, I don't think we actually put out hard numbers. But let me give you a little bit more visibility. So there are some industry benchmarks that we all track. And pre-pandemic, we were always maybe a point better, okay? And then during early in the pandemic, everybody's retention went to single digits, mid-single digits, and then coming out of it, everybody went to the benchmark, historic benchmark, and actually significantly over it by 100 basis points, maybe more than that. And so, when we set the level and we put together a staffing plan that goes with our financial plan and our great HR team takes that as they plan their recruiting for the year, we had a number that was kind of halfway between the worst of the pandemic heights and the traditional benchmark. And we have been operating maybe 3% below that to give you just a sense. And if you take an employee base of 46,000 people and you are 3% better on voluntary turnover, then, Tobey, you can kind of run the numbers in your head what – you don't have to recruit just to stay even. By the way, there's huge benefits to retention and culture and learning. Just beyond a numbers game and being able to do the talent acquisition task, what it does for us from esprit de corps and learning and customer intimacy. So, it's a huge positive for us. And I know good things are going on throughout the industry. Frankly, we're focused on Leidos. And we just completed our all employee engagement survey where we literally go out to everyone who's a Leidos employee around the world and we are just really thrilled with the feedback that we get, the information that we receive, and we can parse it down to very, very small cohorts. And, again, we are significantly over almost every benchmark that our survey provider provides us. And we spend a lot of time to try to make this a great place to work and to take care of our employees. We have this program, I referred to a little bit of my comments around Leidos Life, which is around their career development, flexibility and mobility in how we get the work done and then this new look at total health, where all of us grew up in sort of a comp and benefits world, and post-COVID, we realized that benefits really has to start with the whole self. You have to think about physical health, mental health, financial health, all of those things that come back together. And the implications, I think, for the long term – by the way, our direct labor base is probably a little bit higher than we had planned. That can be favorable to rates, but it's early. And we're only one quarter into it. And we may see some movement in the second half of the year that would be adverse. But given all that we have experienced over the last two or three years, to be where we are today on the second of May, it just makes us feel really, really good about the human talent that we have in the organization. It's only going to provide positive aspects for the company and the positive aspects financially. Because if we can hire faster, we can ramp faster if we retain more people, it's going to pay off in top line and bottom line. Rob, it looks like we're over time. So I think we only have time for one more questioner. And then we'll wrap up.

Cai von Rumohr:

Roger, I have to say you've done a terrific job. You've really transformed Leidos significantly from what it was when you joined the company.

Roger Krone:

I don't know why I thought the last question that I would have in my career would be an easy one. And I think we've covered everything that's going on in civil. Let's see. There is potential for Civil to be at the margin it was last year. But there's more risk, given the performance in the first quarter. And you I think you appropriately described the portfolio challenge that we have as a company. Jim Moos, who runs our Civil group, is all in on driving performance, both in the SES organization and the other parts of his portfolio. And he has tightened the belt, if you will. I think Chris mentioned that we have done some focused reductions in force. We have reconfigured the value stream in the SES business, bringing inside and into our control more of the production processes. We've got a very, very strong handle around our inventory, and how we distribute spares and what have you. Part of what drives that business is the services side. And we've got to get the services side running like a fine Swiss watch. And Jim knows that. His team is fully committed to that. And I expect him to pick up margin significantly throughout the year, whether he actually gets all the way to where he was last year. We will talk about it or Tom will talk about it on a quarter by quarter basis. But the potential is there. We don't need for him by the way to be all the way where he was last year to still make our guidance. But it certainly would be helpful.

Stuart Davis :

Thank you, Rob, for your assistance on this morning's call and obviously thank you all for your time this morning and your interest in Leidos. We look forward to updating you again soon. Have a great day.

Operator:

Greetings. Welcome to the Leidos Fourth Quarter 2022 Earnings Call. At this time, all participants will be in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. At this time, I’ll turn the conference over to Stuart Davis, from Investor Relations. Mr. Davis, you may now begin.

Roger Krone:

Thank you, Stuart and thank you all for joining us this morning. [indiscernible], by the way, Happy Valentine's Day. The fourth quarter marked a strong finish to a banner year for Leidos with record revenue and non-GAAP diluted EPS driving us to the top end of our revenue guidance range and beyond our EPS guidance range for the year. Our performance validated that our diversified and resilient portfolio and our investments in technology and innovation are positioning us for growth in key customer missions including digital modernization, cyber, hypersonics and force protection. Each and every day, our 45,000 people are helping our customers execute on important missions and meet the world's most complex challenges. Against the challenging backdrop in 2022, we delivered on our financial commitments, allocated capital to deliver value for our shareholders, won multiple franchise programs that position us for future growth and significantly grew our talent base. So let me provide more detail on each of these points. Number one, our strong financial performance in the fourth quarter enabled us to deliver on our financial commitments. Record revenue of $3.7 billion for the quarter and $14.4 billion for the year, we’re up 6% and 5% respectively. Adjusted EBITDA margin of 10.7% in the quarter was up 40 basis points year-over-year, which helped drive adjusted non-GAAP diluted EPS to a record $1.83, which represents growth of 17%. For the year, adjusted EBITDA margin of 10.4% helped lead to non-GAAP diluted EPS of $6.60, which was well above our guidance. We generated $105 million of cash flow from operations in the quarter and free cash flow of $52 million. For the year, that translates to nearly $1 billion of cash flow from operations and $857 million in free cash flow, which were right at guided levels. These results came despite multiple headwinds, most notably a protracted continuing resolution to start the year inflation, supply chain disruptions and labor constraints. Even at industry leading scale, we’re nimble enough to pivot as needed. And I'm proud of how well the team pulled together and weather these challenges. Number two, in 2022, we allocated capital to deliver value for our shareholders. Over the year, capital deployment was heavily weighted towards return to shareholders, while still layering in strategic acquisition of the Australian airborne business and investing to grow our core business through capital expenditures and internal R&D. With our asset light model, CapEx was just under 1% of revenues with large investments in airborne ISR and Dynetics and we're seeing those investments payoff in additional aircraft performing valuable missions and key wins in hypersonics, which takes me to number three, business development. This year, we won franchise programs in each segment that position us for growth. Programs like DES in Defense, Social Security Administration, IT in Health, and AEGIS in Civil, contributed to performance in 2022 and have built the foundation for 2023 and beyond. They demonstrate our ability to take away work and target brand new opportunities. In the fourth quarter, which is typically the weakest in our industry, we booked $3.7 billion of net awards for our book-to-bill ratio of 1.0. For the year, our book-to-bill ratio was 1.1. Total backlog at the end of the quarter stood at $35.8 billion of which a record $8.4 billion was funded. Total backlog is up 4% and funded backlog is up 13% year-over-year. After a relatively slow start to the year across the industry, contract activity is improving. Most importantly, our submit volume picked up dramatically in the fourth quarter with $23 billion in submits of which 92% was for new business. Taken together, the two Social Security Administration IT task orders that we spoke of last call were the largest award in the quarter. GAO dismissed the competitor's protest earlier than expected and that program has fully ramped. We also won more than $0.5 billion in hypersonics awards, including Mayhem, our first major contract on the air breathing side and wide field of view Tranche 1, which is the backbone of the nation's hypersonics defense capability. We're pleased that so many of you were able to join us in Huntsville last December to get a clear picture of the opportunities that we see at Dynetics. Our Independent research and development investments were critical to procuring these awards just as they were for our landmark wins in digital modernization. In 2022, we invested $116 million in IR&D and IRAD (ph) has grown at a compound annual rate of 23% over the last five years. We continually invest to develop proprietary tools and unique processes to drive competitive advantage. We've already deployed workflow transformations using the latest generation of AI-based on large language models and we're at the leading edge of combining artificial intelligence and cyber to enable our customers to achieve security levels that are beyond compliance. Speaking of cyber, earlier this month, we announced the latest version of our Zero Trust Readiness Level tools suite that simplifies Zero Trust adoption for government organizations, consolidating a six month to nine month planning process to less than 60 days. We drive digital innovations by working tightly with our product partners. For example, we've partnered with Intel Corp. to demonstrate confidential computing through a hardware-based independently attested trusted execution environment. And just last month, we were recognized as the 2023 ServiceNow America's Premier Partner of the Year. Number four, we significantly grew our talent base. We hired more than 2,400 people in the fourth quarter and more than 11,000 in 2022. Headcount was up 6% for the year and attrition rates continue to subside. We've seen great synergy between our people engagement and technology investment initiatives. Employees in our technical upskilling programs have significantly higher retention, and we more than doubled participation in 2022 compared to 2021. Our technical upskilling programs are aligned with our technology strategy and broad participation is enabling us to enhance our competitive position and deepen our culture of innovation. If you want to build your technical skills over a fulfilling career, Leidos is a great place to work. In 2022, we offered courses in artificial intelligence and machine learning, software, cyber, cloud and digital engineering. In 2023, we're expanding with new offerings in cyber operations, secure rapid software development and specialized learning pass in AIML. We also take learning and engagement beyond the classroom. Two weeks from now, we will launch our seventh annual AI Palooza challenge (ph), where employees around the company will engage with some of the newest AIML techniques in a creative and collaborative competition. Perpetual learning is part of our culture and we make it fun. Before turning it over to Chris, I'll touch on the current budget environment. Demand trends are very positive for our business. Late last year, Congress overwhelmingly passed and the President signed the Omnibus Appropriations bill, funding the government through September. Budgets across the board saw healthy increases, including defense spending, which was up about 10%. The budget address the critical challenges we're facing as a nation, including national security concerns arising from China and Russia and Leidos is well-positioned to respond. Amidst a highly partisan backdrop, President Biden's calls in the State of Union address to support Ukraine, protect our country and modernize our military to safeguard stability and deter aggression received strong bipartisan support. That said, we're anticipating a series of noisy debates over the coming months around the debt ceiling and the 2024 appropriations given the razor-thin majorities and the deep divisions in Congress. As a matter of prudence, we are preparing contingency plans around a potential government shutdown. But we built our 2023 guidance, assuming a continuing resolution beginning in October and extending through the rest of the year with no government shutdown. We believe this is the most likely outcome. In summary, I'm pleased with the performance and the momentum of the company. In the fourth quarter, we posted record levels of revenue, non-GAAP diluted EPS and funded backlog as well as the highest adjusted EBITDA and adjusted EBITDA margin and lowest attrition rate for the year. We anticipate that 2023 will be another good year for Leidos, marked by strong hiring, important new wins, solid growth in revenue and operating income. With that, I will turn the call over to Chris for more details on our results and our 2023 outlook.

Operator:

Thank you. At this time, we will be conducting question-and-answer session. [Operator Instructions] Thank you. And our first question comes from the line of Robert Spingarn with Melius Research. Please proceed with your question.

Roger Krone:

Good morning, Rob.

Robert Spingarn:

Chris, about the guidance, I wanted to ask you if you might not give us some more detail on a segment basis for the -- what drives the 2% to 5% growth across the segments and then how do the margins look relative to the '22 performance on a segment basis?

Robert Spingarn:

Yeah. And then, Roger, going back to the security products business and the supply chain there, what parts of that might you bring in-house?

Robert Spingarn:

Thanks so much.

Operator:

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

Roger Krone:

Good morning.

Chris Cage:

Well, you nailed all the big players there, Sheila. So you're on top of it. First of all, I mean, the SSA team did an outstanding job, and couldn't be happier with the transition, the fact that the customer did the right thing. Let us get started in the fourth quarter, we're off and running, and we expect that to be a significant contributor to growth in 2023, so that is solid. RHRP, finally, we feel very confident that, that will start to ramp up here really at the tail end of the first quarter. There'll be some activity in March, but think about that as building from Q2 onward through the rest of the year. So that gives us solid growth momentum. [indiscernible] is still again early. I'd say the team is doing excellent work in QTC. The story got a little complicated last year because some of the pre-discharge work went to multiple competitors. We also have the international work that we won that's ramping up this year. So I'd say that's -- we expect growth in that area, but more color on that as we get a quarter or two down the road. And then, finally, DHMSM, this year, there's, I would say, towards the tail end of the year, we've got to continue to work to offset that ramp down on the deployment side, but the teams have been doing excellent work to expand the capabilities within the software that's been deployed. And so we're continuing to find opportunities to do that. I don't know, Roger, if there's anything more you'd add there.

Sheila Kahyaoglu:

Okay. No, that's helpful. And then I wanted to talk about margins as well, defense was solid in the quarter, but I think it was mainly stable that in Q3 and Q4 have seen really good performance there. So what's sort of going on? You mentioned larger programs, but I didn't think you had anything in particular there. So how do we think about Civil margins going forward and what's the driver of the better performance in the second half of the year?

Roger Krone:

Sheila, I would add, if I could, because I know you followed us for a long time. What's been great about our civil business is that it's growing. And we have a base of business in that segment that is sort of infrastructure support business. We run Antarctica. We've got the Hanford contract. We do some other work for DOE. And as great that work is, it traditionally does not carry the margin of the rest of the company. And so as Civil grows top line, you see the margin increase because we're adding new business sort of at the margin and the mix is shifting in civil. So the more we grow civil and we hold the infrastructure business constant, the more growth in margin you're going to see. And the team there has done a great job of growing.

Roger Krone:

Yeah.

Operator:

The next question is from the line of Bert Subin with Stifel. Please proceed you’re your questions.

Roger Krone:

Good morning.

Chris Cage:

You make it sound so easy, Bert, you're right. There are a lot of tailwinds, no doubt about it. But we…

Chris Cage:

I would also point there's a couple of spots in our Intel business. It's been fairly public, the focus Fox (ph) procurement process. And while that has some room to go ahead of it still to see how that fully plays out. That's an area that could be -- put some pressure on revenue growth if it doesn't go our way. And then, we lost a program a year ago, and this is how long things take called items UFS. And so the good news is the Intel leadership team did a great job throughout 2022 to continue to support the customer during transition, but now we're fully rolled off that program. So that's a little bit of a headwind. But by and large, we've had great success on our recompetes. I really love the team's performance there. There are a lot of tailwinds that are known, but we also have seen customer behavior take longer. And especially if they're worried about the budget environment transitioning into government fiscal year 2024. So our hope is, we'll build momentum through the year. We'll have some successes, and we'll be able to update you in a positive direction.

Roger Krone:

Yeah. I think that's a good way to build your model. And I was with a customer yesterday, actually, we had a long meeting on the program. We all want to move fast. This is about transitioning non-combat support organizations to new, what we call DoD net. And -- but we want to do it the right way. We want to do it when we're ready, and we all want to move fast because it will save money. It will help interoperability between all these support agencies, but we want to do it the right way. We don't want to create a negative user experience for all the people that are supporting the military. And so the discussion was, well, okay, are we -- can we move up some of the transformations and some of the transitions, and we're looking at that. So I think there is potential for it to be higher, but we're not guiding to that. And we'll talk to you quarter-by-quarter as to what our success has been and whether we've been able to increase the ramp. And I will tell you, we're very enthusiastic about it in '24 and '25. As it fully ramps and we're doing these conversions, how much more than what you described we can do in '23, we have yet to see. But I can tell you, the customer wants to move fast, we want to move fast. But we all know if you -- sometimes you move too fast and you create a negative user experience, you're really not serving the user well, and we don't want to get ahead of ourselves.

Roger Krone:

Yeah.

Operator:

Our next question comes from the line of Matt Akers with Wells Fargo. Please proceed with your question.

Roger Krone:

Good morning, Matt.

Roger Krone:

Well, again, Matt, with the growth we've had and the growth that we see ahead of us, there are some investments -- modest investments in working capital for a few particular programs. If we're able to win a program like FINS, for example, there's an initial amount of equipment that you have to procure and bring on board to support the customer. So there are a few things like that in our pipeline that we're anticipating. We finished the year at 58 days DSO, and that's good performance. I think there's opportunities to drive that even lower and we're focused on that as a finance team with our lines of business leaders. So we thought we'd start the year at $700 million. I mean it's not a never a slam dunk, but our focus is to continue to build momentum on the cash side. But nothing out of the ordinary as it relates to working capital investment, but there are a few programs that we are anticipating needing some support as we win them and grow them.

Roger Krone:

Well, first of all, no, because we really haven't -- we haven't gotten to that level of planning where we've -- in order to have -- to quantify, we'd have to pick a date and then go through and figure out which programs would be deemed essential and which programs would not be deemed essential, then how we would go mitigating. What we do, and unfortunately, we have done this way too many times as we get our contracts organization, and we go through our 3,000 or so contracts and try to understand how each contract would perform in a government shutdown and some are easy. They're deemed essential. We know those will continue. Some we know will not be deemed essential. And then as part of our preparation, we start to have conversations with contracting officers about things that might be in the middle and work with them on ways that we could mitigate a shutdown. And it just behooves us to be prepared. And by the way, we have learned the better prepared we are, the less likely it is, we'll ever use the plan. but we would never want to maybe McCarthy and the President have a meeting. I think they're going to meet again in a couple of weeks. And if it comes out of that and we get to June, and we're not prepared, then we haven't done our job to manage through a government shutdown as best we can. And that's the process really that we have kicked off. And unfortunately, we have done this before. So we have a pretty well-developed playbook and we have gotten our playbook out and dusted it off.

Roger Krone:

Yeah.

Operator:

Next question is from the line of Peter Arment with Baird. Please proceed you’re your questions.

Roger Krone:

Hey. Good morning, Peter.

Roger Krone:

NGEN?

Roger Krone:

Well, it's pretty much fully ramped. And you're really doing well. We're in full possession of the network Peter, I know you know the program well, but our first task was to take the custodianship of the Asure Network, okay? So we've done that. Now the challenge is to transform that network to modern technology. And we're in the process of keeping the call center up, maintaining the network, trying to get the quality of service up while we move to the new environment. And there is opportunity, we believe, this year for additional scope through special projects and on-contract growth in task orders. And we are starting to see some of that. I think we have talked in prior calls that was a little slow in coming. But we have talked to the Navy and frankly, I've talked to our program manager, and we're starting to see some of that break free. We see lots of opportunities where technology can add value to the user experience in the Navy. And so we're constantly making suggestions to the customer about things that can be done to improve the network and which would end up in growth for us, but more importantly, would end up in better quality of service for the user. I don't know, Chris, do you want to add?

Peter Arment:

I appreciate that color. Hey, Roger, you mentioned technology kind of insertions and things that AI has obviously gained a lot in the press here recently with chat GPT (ph) and other things. Are you seeing opportunities to really automate some parts of your business where you can really potentially improve margins?

Peter Arment:

Appreciate the details. Thanks, Roger.

Operator:

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

Roger Krone:

Good morning.

Roger Krone:

Yeah. Okay. Those are -- you two, I would say, lightly linked subject. So let me talk through them and I'll have Chris clean up after me when I make a mistake. But given the year and what's going on, on the Hill, I think the Omnibus is about the best we can expect. And my hope and our plan is McCarthy, the President find a way to raise the debt ceiling long before the June date. And the debt is really paying for past years for authorizations and appropriations that have already been made, commitments that the country has been made, and we're just funding the government. And that will probably fund it we're hoping a little bit higher than the 2023 levels. I think we can count on that. And as you know, it's always a discussion between defense and nondefense, and if we raise defense, then there's a group of elected officials who want to raise the non-defense budget at the equal amount. And that may tamp down a little bit of the raise in defense, but we're coming off such a robust defense budget this year that I think we will all do okay. Now how does that roll into Dynetics? And again, if you were down in Huntsville and I'll describe a little bit what you would have seen is a lot of productions that are in low rate initial stage of the program, where we're building the first age preproduction or production units that will be followed in '24 by a fairly aggressive ramp and significant production. We're talking instead of one a month, one a week, two a week. And we could go through the different programs. I won't do that now. Those monies are pretty much already authorized and appropriate, okay? Not in every case, I won't go program by program, but if we get an omnibus then the ramp that we talked about in December is certain because these are programs of records that will be fully funded. I won't go into all the scenarios if there's a debt ceiling or there's a reason and all the things that the government could do, which is certainly within the realm of possible. We think the high probability is they'll get an omnibus. It will have some growth in it. There may be a Ukraine supplemental depending upon how it goes and it certainly doesn't appear to be lessening. So they may cover those expenses with the supplemental as they have done in the past. And then our production ramps in '24, which are again, we think we're very pleased. I think they're very attractive. Those would be fully funded and we would see significant growth in Dynetics in '24, and I'll let Chris add to that.

Seth Seifman:

Cool. Excellent. Okay. I’ll leave it there for this morning. Thanks very much.

Operator:

Next question coming from the line of Ken Herbert with RBC Capital Markets. Please proceed with your questions.

Chris Cage:

Hey. Good morning.

Chris Cage:

Well, Ken, let me get started. Roger might pile on. So first of all, very proud of the team, second half of the year as a team, we really rallied and showed we're capable of on the cost control, margin improvement front. And quite honestly, that was despite the fact that we had some program areas where we could have done better. And so I think that gives us some confidence and momentum going into '23. Now a couple of things to keep in mind. The Health Group overall for the year finished still above 17% on margins. right? So fourth quarter was definitely more in line with what expectations are going forward. But earlier in the year, there was still some stronger performance from caseload and QTC and other things that drove that higher. So that will still moderate down a bit, but we do intend to capture the savings and the margin upside that we've been able to realize in other parts of the business. And we're not done in Defense Solutions and in civil for sure. And as we build our pricing, we have a rigorous process with our competitive intelligence team to kind of keep us in tune with where we need to be on a price to win front. We factor that in and making sure that we can remain competitive while still trying to capture some of the margin upside. So the guidance is balanced for next year. And again, there's momentum there. I wouldn't say there's any super low-hanging fruit on the cost reduction side because we do focus on that continuously. But there's still more that we can do, and we're focused on hitting that 10.5% long-term margin target or greater by 2024.

Kenneth Herbert:

Great. I’ll stop there and pass it back. Thanks, Roger. Thanks, Chris.

Chris Cage:

Thanks, Ken.

Cai von Rumohr:

Yes. Thanks so much. So I think early on, you talked about 6% headcount growth, and I would have to assume wages go up about 3% which would say payroll is up in the area of 9%, and your revenues are up 2% to 5%. Help us square those two items?

Cai von Rumohr:

Thanks. And the second one is, you have very strong bid submits. And Roger, you mentioned we have a very strong FY '23 budget. So there's lots of money available. Can you give us some color on what you expect your book-to-bill might be in '23 and what that would suggest for '24?

Cai von Rumohr:

Thank you very much.

Operator:

Our next question is from the line of Jason Gursky with Citigroup. Please proceed with your question.

Roger Krone:

Yeah. I mean, I'll talk kind of top level. Chris can add in. And this is, just what I think. So everybody has their opinion there's a lot that's being written is what I think I'm seeing is customers wanting to get things under contract before we end up in this argument over the debt ceiling. With looming government shutdown, who knows what comes out of those discussions. If you've got a customer and you've got appropriated funds, you're going to really work hard to get those committed between now and June. And so we are seeing a little bit more activity, and we're hopeful that these folks will try to move a little faster and get these things under contract. And then we probably end up with an agreement on debt ceiling with some kind of a future trade on some kind of a top level budget constraint. I mean I don't -- I'm not smart enough to know what that will look like. Last time this happened, we got sequester. But I suspect it will be something just what I read about how McCarthy got elected as a speaker, there is some kind of a budget deal that's going to be cut for the long term. But that could be by -- and I don't really understand how you balance the budget in 10 years. Again, that's not my job, but I run the numbers, and it seems unbelievably difficult. But that's going to put a damper perhaps on what the budget could be. You're starting to talk now 25%, right? And so I suspect that if you have money and you have a program and you have a mission with requirements, you're going to work as hard as you can to get those things committed in '23. And I think that speaks well. And then as you know, we get an award in '23 that's a '24, '25, '26 revenue. So again, our future, we think, is still looks relatively bright. And then plus the diversity in our portfolio, the Civil group has been growing very strongly. The health group has been growing very strongly. So we've been working really hard to make Leidos somewhat resistant to the vagaries of what happens from our elected officials. I don't know, Chris, you want to add anything?

Jason Gursky:

Okay. And then quick clarification. Can I ask one clarification. You mentioned the CapEx at 1.5% this year. And I think you mentioned part of that is being driven by Australia. I'm just curious if that has to do with the recent acquisition and kind of what's going on down there, specifically on.

Jason Gursky:

Great. Thank you.

Stuart Davis:

Hey, Rob, we're running a little bit over, but we have time for one quick question.

Louie DiPalma:

Roger, Chris, Stuart and Gabe, good morning.

Roger Krone:

Good morning.

Roger Krone:

Yes. Well, that's great. I mean Louie, you really are following things well, and I think you really understand our programs. I would add to that, we have some unmanned vehicles that are made of Dynetics. By the way, we have some counter drone programs that we probably exposed to a little bit to when you were down in Huntsville, where we actually have a radar on Jeep and we launch a drone, and it can go -- or attack another drone. And so -- but we see exactly what you see is the use of uninhabited vehicles under the water on the surface in the air, and we'll call it in the rare air, up between 60,000 and 80,000 has -- first of all, I will tell you that it has been robust. There's been a lot of work already done. The MUUV is a program of record. So we won that, that's a program of record that's fully funded. The Sea Hunter and the autonomous vehicles in the Navy are not yet programs of record but the Navy is doing a lot of experimentation. They're doing some things in the Mid-East that have really demonstrated some capabilities. As you have mentioned, we've done a lot with Sea Hunter Sea Hawk and Sea Innovator. And we believe there is a strong demand for those. I think for us, on the surface. The next thing for us may not be a full program of record, but they may buy additional vehicles to extend their experimentation, which they can do under an OTA that would happen much faster. But I believe that the Navy is committed to having a significant percentage of their fleet both unmanned and optionally manned. And our autonomy software and the things that we have demonstrated really set us up well to capitalize on that and to bring them the capability that they need. There are a couple of other programs. There's MUSV, there's LUSV that are out there. They are going through their development processes. But to get all the way to the program of record, I think, is years away, but that doesn't mean that the Navy won't be spending funds to further their understanding and to experiment with unmanned capabilities, and we would be right in the middle of those activities. So Louie, thanks for the question.

Roger Krone:

Yeah.

Stuart Davis:

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

Operator:

Greetings. And welcome to the Leidos Quarter Three 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Stuart Davis, Senior Vice President, Investor Relations. Thank you, sir. You may begin.

Roger Krone:

Thank you, Stuart. And thank you all for joining us this morning. Our third quarter results demonstrate the momentum in our business as we continue to report revenue growth at the upper end of our guidance across our diversified portfolio. In addition, our dedicated team delivered earnings in excess of our forecast and generated the highest quarterly cash flow from operations in our history. These results position us well to deliver on our full year financial targets as we make the world safer, healthier and more efficient. As usual, I'll touch on our financial performance, capital allocation, business development performance, and people. First, our financial performance for the quarter was strong and ahead of consensus at both the top and bottom lines. Record revenue of $3.61 billion were up 4% year-over-year. Adjusted EBITDA margin of 10.3% was up 10 basis points sequentially and non-GAAP diluted EPS came in above our forecast and consensus. Our third quarter performance and improved visibility enables us to raise our revenue outlook and derisk our earnings for the full year. We also generated a record $748 million of cash flow from operations. This puts us on track to meet our cash commitment for the year, strengthens our balance sheet and positions us for future capital deployments to benefit shareholders. Which brings me to point number two, our approach to capital allocation. Yesterday, we closed our acquisition of Cobham Aviation Services, Australia's aviation Special Mission unit. This business provides border force airborne surveillance, and marine safety search and rescue, and generates roughly $100 million in annual revenues. It is immediately accretive to both non-GAAP EPS and EBITDA margin. At this point in our strategic journey, the Cobham acquisition is a great example of what we're looking for. It expands market access, provides us franchise programs with a customer of strategic importance and complements our existing business, all at a multiple below ours and a price that enables our shareholders to benefit from future revenue and cost synergies. Our cash balance at the end of the quarter was $807 million as collections were especially strong in the back half of September to close out the government fiscal year. Our plan is not to accumulate cash. We just paid for the Cobham acquisition, and we'll be paying down some debt to move closer to our target leverage ratio of 3 times. Our balance sheet enables us to steadily deploy capital in productive ways. Given the strength of the company and a valuation that doesn't reflect our long history of driving steady earnings growth and cash generation, we'll lean towards share repurchase when we have deployable capital. Number three, our business development results demonstrate that our strong positioning in the government technology marketplace is enabling us to navigate a difficult environment. The current timelines continue to extend and DoD outlays continue to lag budget authority. With net bookings of $4.1 billion in the quarter, we achieved a book-to-bill ratio of 1.1 and grew backlog to $35 billion or $35.4 billion on a constant currency bases. We also had nearly $1 billion of third quarter awards protested. Absent the protests, book-to-bill would have been 1.4. Highlighting some important awards. We received a five-year $1.5 billion task order to support the DoD with rapid technology insertion to enhance C5ISR missions globally. We expect to receive the full award value over the life of the contract. But in accordance with our policy, we only booked $100 million in the quarter. This award, known as Sentinel, is all about getting capabilities into theater and to the combatant commanders quickly. As a solution agnostic integrator, part of our role is to find innovative technologies that can be rapidly matured, proven and integrated in support of multi-domain operations. Sentinel fits within the Joint All-Domain Command and Control or JADC2 umbrella. Our positioning on JADC2 was also bolstered by the Air Force's selection of the Advanced Battle Management System Digital Infrastructure Consortium. With four other consortium members, Leidos will work to deliver the Air Force's vision for distributed battle management and decision advantage by enabling speed, security and integration at scale. NAVSEA awarded Leidos a $358 million contract to design and build a medium-sized unmanned undersea vehicle to provide autonomous oceanographic sensing and data collection for operational intelligence as well as to support mine countermeasures. We also received our first task order on the $11.5 billion Defense Enclave Services contract. The $138 million task order will lay the framework and begin to consolidate, integrate and optimize five agencies on a common network architecture through digital modernization and transformation. We successfully completed the transition period and have assumed operational responsibility for DODNet and DISANet. And in a key win for our space business within Dynetics, we received a subcontract with Northrop Grumman to develop hypersonic defense sensors for the Space Development Agency. We have more than 40 years of experience developing and flying space-based electrooptical and infrared sensors and payloads for a variety of missions. Through this award, we'll develop and build the sensor payload for a proliferated constellation of low Earth orbit satellites for the Tranche 1 Tracking Layer. The Tracking Layer constellation will detect and track advanced hypersonic and ballistic missile threats as part of SDA's missile defense architecture. On the predecessor contract, our Tranche 0 payload is on scheduled to launch by the end of the year. The Tranche 1 design will increase coverage area, while reducing payload size, weight and power. Eventually, these constellations of satellites will form the core of a new National Defense Space Architecture, providing global coverage and adding resiliency in the country's missile warning arena. As a reminder, we'll be hosting an investor site visit at Dynetics in Huntsville, Alabama on December 1. Please reach out to Stuart if you're interested in attending. And the final key win that I'll touch on this morning is the re-award of our IT support to the Social Security Administration. As of the second quarter call, our award was protested by the previous incumbent. And after a resubmission of proposals, the SSA re-awarded all of the work to Leidos. The incumbent once again protested the award and the new GAO review period expires on January 3. And lastly, point number four. Leidos is an attractive destination for great talent. In the third quarter, we hired just over 2,800 people. And year to date, we've hired more than 9,000 people and increased headcount by more than 2,000. It's still early, but voluntary attrition is trending in the right direction, and we don't expect that staffing will significantly constrain our plans for next year. Our dedicated and capable people are a key differentiator for us and an important national asset. Before turning it over to Chris, let me touch on the federal budget landscape. As expected, the federal government is operating under a continuing resolution at last year's funding levels until December 16. Congress is still working on the appropriations and authorization bills for government fiscal year 2023. Nothing will get voted on until after the November 8 elections, but we expect that robust budgets will get passed before the end of the calendar year. Outlays are beginning to improve which bodes well for future growth. Chris, over to you.

Operator:

[Operator Instructions]. Our first question is from Gavin Parsons with Goldman Sachs.

Roger Krone:

We don't guide to 2023 until the end of the year. And so, we're not going to put out any numbers. What we will tell you, though, is that if you go back to our Investor Day and we put some longer term goals on Investor Day, and we're still confident with the numbers we provided you. I think it was October a year ago. But we're still very excited about what's going on in our space and we had a great quarter and we expect 2023 to be strong.

Roger Krone:

Well, maybe I'll start and then Chris can come back in. We, especially in our mission and operations area, find customers who want to accelerate capability and look to the contractor base to make investments to get them capability into theater faster. And the army has some airborne programs. In fact, I think our RFP just came out a week ago and we made some investments ahead of that program. And we hope to get a decision, which will be next year, and actually start the program next year. When we make an investment like that, it's usually on a pretty short string. And it's very consistent with the airborne work that we already do, and those margins tend to be above our corporate average.

Operator:

Our next question comes from Robert Spingarn with Melius Research.

Roger Krone:

Of course, what we have been saying for years is we have been portfolio shaping and positioning the company both in Health, Civil and Defense, to be in the swim lanes that are moving faster. And so, just as I reflect on all three of those, of course, our Health business continues to have really, really strong momentum. We're almost through the COVID catchup and back to normal growth levels. But we see continued growth in our Health business really driven by CMS, Social Security, and what's going on in DHA, and it's just been a great performer for us. In Civil, we've talked now for quarters about the resurgence in air travel. And we're seeing strong resurgence certainly in the US, as I think all of us can attest. And we're finally starting to see the revenue passenger kilometers pick up internationally. And our SCS team has had probably more meetings with customers in the last quarter than they did all of last year. So we're traveling again. And that bodes well for increased orders, which will lead to increased sales in our global security business. And then Defense, which we actually – if you think about a year ago – thought was probably going to be our lower growth business. But as we've all come to learn, the world is a very complicated place and it continues to be very, very complicated. And I think those issues require that both the US and our allies continue to invest, maybe more than they would otherwise like to in the defense of the nation. And so, our Defense business has really held up held up well. And we don't see anything on the horizon that changes our view of that future. And I think it really speaks to some of the decisions we made to shape the portfolio and emphasize on the parts of the business that we did. And I'll highlight one other thing. It's a smaller business for us and we don't often talk about it. But within the Civil group, we have a commercial energy business. That has just been going great. We do a lot of engineering for investor owned utilities and energy savings programs for large production facilities. And that business has been growing in double-digits. And it's interesting that utilities are connected to 5G because you put 5G on towers and you need engineering for that. And that business has turned out to be a huge growth engine for us as well. I don't know, Chris, you want to…

Robert Spingarn:

So, Chris, on that last part, you talked about up to 2024. But when I think about five years from now, for example, if Dynetics is growing faster than the rest of the company, do you see the overall portfolio, the three segments, the same relative sizes in that long-term timeframe, five years out?

Robert Spingarn:

Defense is the biggest piece by double.

Roger Krone:

Rob, a point I would make as you think about the coming five years from now, the Health is primarily a kind of a people services driven business and I think it will continue to grow well and we'll provide health managed services to active military and veterans and others. But five years from now, some of the programs that we've been talking about, [indiscernible] or SS, they'll be an in significant production. And that will help to look change the complexion of the company a little bit, so that we have 15% or 20% of month-over-month production programs generating higher margin than our average. And what we're going through now in 2022 and 2023 is the development of the programs in enduring fires, the high energy laser, the Common-Hypersonic Gide Body, which is just ramping up, and the stuff we're doing on Tranche 1. By the way, there is a Tranche 2 and a Tranche 3. So if you think about what we will look like five years from now, we will have the base business that we've always had and we will add to it, kind of above that base some significant production program. So we're really excited about the company five years from now.

Spencer Breitzke:

This is Spencer Breitzke on for Cai. Can you talk about if you've seen a pickup in award activities since the Pentagon occupancy limit was lifted in September?

Roger Krone:

A comment I would make is Bill LaPlante finally was confirmed by the Senate and put in as the acquisition exec in the Pentagon. And I would say since he's taken office, we've seen sort of upbeat in activity. Bill's been very accessible to industry. There have been a couple of tri service meetings with Bill. And he's trying to, I think, accelerate the RFPs and to get outlays where they need to be. And I think that's a real positive sign. I would look more towards that than I would the occupancy limit on the Pentagon. But I will confirm whether it's delivered on the Pentagon or not, I think we've probably been in the Pentagon more in the last quarter than we were in the first half of the year. So I think it all bodes well that will – increase the activity and we'll get some of these procurements under contract.

Eric Yan:

This is Eric Yan on for Matt. Just on CR, could you talk a little bit about the environment we're in today compared to last year? Just what kind of impact have you seen from the CR so far? Also, if you think it'll get extended again into next year?

Operator:

Our next question comes from Peter Arment with Baird.

Chris Cage:

Well, definitely. And certainly, something we've spent a lot of time on throughout the year and even most recently as a leadership team. So I think what we've been doing is, obviously, our merit budget pool has been increasing and we've seen that consistently over the course of the past two to three years and expect it'll tick up again as we're looking ahead to 2023. So in the past, that was a sub 3% kind of annual pool and then we'd have some one-off increases over the course of the year. I think what we're seeing now is above – mid 3s to 4 or higher in certain cases. And so, that will roll through the top line as a tailwind on the cost reimbursable programs, which I'm sure you're aware are in the order of 50% of the portfolio. So that's goodness there on the top line contributor for growth. The balancing act is managing that on the fixed price and T&M programs. And we've been successful there. I would say that managing margins this quarter at 10.3%, could have been better. But we're looking ahead to a strong Q4. So we're very thoughtful on building our pricing up and passing those inflationary cost pressures along to our customers where we can. Certainly, it'll be priced in as we put together next year's forward pricing rates. But it's absolutely something we're spending a lot of time on as a management team and being thoughtful, especially for the areas of talent that are in the highest demand.

Roger Krone:

I see if I can do this quickly. And we've always described the US business as sort of an RFP, get certified, compete for the business. And it's funded really through authorizations and appropriations. That business continues to go well. There's opportunities to insert new technology, what we call CT or computer tomography at the checkpoint for carry on. And we're in the process of getting our equipment certified. And we continue to see success domestically or in the US, along with our competitors. So that business is great. What will really drive growth in that business is the return of the international business, and the international business tends to be funded by ticket surcharges. So it's more related to travel volume than it is in the US where it's essentially funded by the federal government. And it's a lag. So the tickets, traffic has to come back, the ticket volume has to go up. The airport authorities, every airport has a different governance structure, they have to be confident that the volume is there. And then they start to engage with the contractor base, they put out RFPs, we go and talk, we do demos, right. And then it takes literally months or a year or two before there's acquisition, you get certified, you get an award, you build the equipment, you deliver it. So, unfortunately, there's a long timeline to this recovery. But the good news is, at the front end, the RFP activity, the demos, the requests that we have for specifications and the like is up significantly year-over-year. And I said our team is literally flying all over the world, talking to airport owners and operators about what's available. And I'll make another point. We've done this before. During the period, kind of the COVID period, we couldn't use that as an opportunity to up our investment in technology and our product. We wanted to make sure that we had state-of-the-art detection equipment. There are a variety of new substances that airports want to detect, fentanyl being one of them. And that required us to tweak our algorithms. There are some other reasons why we tweaked algorithms in the US. But we took the time, right, when maybe production wasn't where we wanted it to be. But we took our team and used it to invest in technology to make sure that our products were worldwide competitive. And now, we're benefiting from that, is that we are at the leading edge with competition on what we have to offer. And customers realize that and they've asked us to come and talk to them. So we're excited about that.

Roger Krone:

Yeah, I think everyone knows that China is still essentially shut down for COVID and that does dampen travel in the Pacific region. But Chris is right, we've had a lot of trips to Europe.

Colin Canfield:

Certainly back on the defense production and airport recovery comments, can you just maybe talk us through the margin bridge from here to 2024's Investor Day target of over 10.5%? And then maybe discuss which programs that you guys are developing under fixed price and how you think about kind of that cash risk versus getting to production?

Roger Krone:

I'll just add a sense or two, kind of footstall what Chris discussed. So, really two ways we drive margin. Performance on the existing contracts and then changing the mix, so that we have programs that on their face have higher revenue opportunity. We have always focused on performance, and that's your write ups versus write downs and control of indirect costs and overhead. And we're a very lean company. We have less than 100 senior executives in the company. We run a $15 billion, $14 billion company with that, and we continue to focus on that. And we've had success. But in our success, we are not adding to corporate office overhead and indirect costs. And then on mix, and that's been our story now for years, is that we do have in our portfolio some businesses where we operate in Antarctica, we do large M&O. And those tend to be below the corporate average. And over time, those were important programs, important programs for the nation, but we want to complement those with programs that have higher margin potential. And we talked about production programs earlier. Even in some of our digital transformation programs, if we can get special project work, if we can do enhancements, we can drive those to the higher margin. If we do all of that, the 10.5% is achievable.

Chris Cage:

Colin, again, I think the team has done an excellent job. GENESIS has been a growth driver for us this year. And we certainly are pivoting into a point where it's going to taper down a bit, and we're approximately two-thirds deployed through the program at this point in time. So, 2023 will continue on that cadence. What I will say is, certainly, the customer, and Roger can elaborate on this, there's been a lot of discussion, getting the base deployment, but then enhancing the capability of the software suite that we've got available to the customer. And there's been a lot of discussion and opportunity and growth that we'll see coming on the back of that, that take full advantage of what the capabilities are. So, little early to paint the picture on how much of a step down we'll see as the deployments moderate. But we're very cognizant of that. And the Health team has been working hard to find opportunities to offset that. Roger, you want to…?

Operator:

Our next question is with Bert Subin with Stifel.

Chris Cage:

Well, definitely. Part of what we're not seeing is that the VA didn't necessarily set up a way to track that explicitly just yet. So the team is working to make sure we understand what's coming through as the PACT Act cases versus otherwise. But I think the main point is, this is ahead of us. Right? And, yes, it could be a contributor to the fourth quarter, that would be something, if it were to happen, could be one of the catalysts to push us up in the margin range as an example. So that's why there's a range there. But certainly, for 2023, we're bullish on how that plays out. And we've seen good overall referral volume. We were navigating throughout the year this recompete and reallocation of some of our other work to multiple competitors. But for the most part, that's settled out, maybe there's a little bit more of that to go. But I certainly look at the PACT Act case volume to be one of the areas that can drive growth for us in 2023.

Chris Cage:

Bert, so a couple of things going on there. Obviously, we'll still see interest rates have been trending up, right? That'll be a little bit of a headwind as we look at the fourth quarter on the below-the-line item. Diluted share count, we're at 138 million, rounding down. There's a scenario where it could pop to $139 million and round up. So, that's kind of in play there. And we talked about the tax rate, right? So, taxes were a driver, the tax rate being higher than we expected at the end of the year. The team is working hard, as they always do, to minimize the tax expense. But I'd say it's more of the below-the-line items that are kind of in play there. I think, operationally, we feel solid about the trajectory of the business.

Roger Krone:

Yeah. Yeah. We're expecting 2024 to be at or above pre-COVID levels.

Ellen Page:

I understand that you don't want to give 2023 guidance. But are there any major program drivers beyond the SDES [ph] and RHRP to think about? And we always hear about your successes, but are there any losses to be aware of?

Roger Krone:

Ellen, what's been great about the journey at Leidos is losing a $1 billion program when we were 5 or 10 years ago was really, really material for us. Now, we're bidding probably north of $50 billion worth of stuff in a year. And so, if we were to lose a $1 billion program – and, clearly, we don't win everything, and so there are programs like that that we have not won. Usually new business and takeaways, not a recompete. It tends not to have a significant impact. All companies do this. Sometimes we stretched a bid on something that's maybe a little bit outside the strike zone, and we lose those, but it helps to build a relationship with the customer. And then maybe when we bid the next program, we win those. Like all companies, we do lose programs. Not every week, but often. But we win a lot more than we lose, which is what we're trying to do. And as Chris said, we have a lot of work to do between now and the end of the year. It's amazing how many RFPs have dropped and how busy our team is, frankly, across all five of our business groups and three of our reporting segments and writing proposals over the two holidays, which tends to be the way things work in our industry.

Chris Cage:

I think that's one that I would say the best days are ahead of it as far as profitability goes, quite honestly. Revenue has settled into a nice range, team's done a great job, staffing levels are robust. And so, our team, DJ, our program manager, Steve Hall [ph] (51:27), our ops manager, have done an excellent job preparing that program for success. But I still would say, our expectations, our margins will continue to tick up. I don't think you should expect significant movements, but it should be a nice tailwind for us as we look ahead to 2023 and beyond.

Mariana Perez Mora:

[indiscernible] acquisition clause, what's your appetite to increase international and/or NATO exposure?

Roger Krone:

Mariana, we tend to go where the US goes. The Five Eyes countries, the NATO aligned countries, and then we tend to go where the world is complicated. And right now, Europe and the Pacific Rim are places that we see growth. And so, we're excited about that. And Chris mentioned, I think we sell equipment through the SES business maybe to 125 different countries. Not all of that is direct, some of that is through manufacturers reps, but we have people probably in 40, maybe 45 different countries supporting some of the SES products at commercial airports.