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Leidos Q4 2021 Earnings Call Transcript


Listen to Conference Call View Latest SEC 10-K Filing

Participants

Corporate Executives

  • Stuart Davis
    Senior Vice President, Investor Relations
  • Roger Krone
    Chairman and Chief Executive Officer
  • Chris Cage
    Chief Financial Officer

Presentation

Operator

Greetings. Welcome to Leidos' Fourth Quarter 2021 Earnings 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] Please note, this conference is being recorded.

At this time, I'll turn the conference over to Stuart Davis with Investor Relations. Stuart, you may now begin.

Stuart Davis
Senior Vice President, Investor Relations at Leidos

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our fourth quarter and full fiscal year 2021 earnings conference call. Joining me today are Roger Krone, our Chairman and CEO; and Chris Cage, our Chief Financial Officer. Today's call is being webcast on the Investor Relations portion of our website, where you will also find the earnings release and supplemental financial presentation slides that we'll use during today's call.

Turning to Slide 2 of the presentation. Today's discussion contains forward-looking statements based on the environment as we currently see it and, as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially.

Finally, as shown on Slide 3, during the call, we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is included in today's press release and presentation slides.

With that, I'll turn the call over to Roger Krone, who'll begin on Slide 4.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Thank you, Stuart, and thank you all for joining us this morning. 2021 was a banner year for Leidos, with industry-leading organic revenue growth and expanded profitability. In addition, we enhanced our market presence during the year with strategic acquisitions and investments that added important technical capabilities. Despite the ongoing impact of COVID-19 and an extended Continuing Resolution, we are positioned to grow in 2022, bolstered by our scale, differentiated technical offerings and dedicated workforce.

In my remarks, I'll address four topics; our financial results and outlook, capital allocation, business development and people. Number one, our financial performance in the quarter was strong despite a challenging market. Revenues for the quarter were $3.49 billion, up 7% year-over-year. For the year, revenues grew organically across all reportable segments and were up 12% in total compared to 2020. In 2021, our adjusted EBITDA margin of 11% represented the sixth consecutive year of margin expansion and non-GAAP diluted EPS was up 14% to $6.62.

We generated $210 million of cash flow from operations in the quarter and free cash flow of $177 million. For the year, that translates to $1.030 [Phonetic] billion of cash flow from operations and $927 million in free cash flow. These results came despite well-documented headwinds, most notably a protracted Continuing Resolution, which slowed both tasking on existing contracts and the award of new opportunities; a resurgence of the pandemic, which lowered workforce productivity and limited our interactions with customers; and a national security community transitioning to new threats. I am proud of how well the team weathered these headwinds.

In 2021, we achieved our guidance for all of our metrics, but the standout metric was cash, which came in well ahead of our expectations through close coordination with our customers and strong operational focus. Our asset-light model, lean cost structure and efficient collections process enabled us to generate strong cash flow that we can deploy to grow our business and drive value for our shareholders, which brings me to number two, capital allocation.

Over the fiscal year, capital deployment was balanced, with a mix of strategic acquisitions, debt paydown towards our target leverage ratio, an enhanced dividend and share repurchases. In the fourth quarter, we made a strategic investment in HawkEye 360 to build on our multi-decade heritage of serving national security space customers. HawkEye 360 is driving innovative solutions around space-based radio frequency data and analytics, and we're confident this investment will enable us to better serve key customers who safeguard the United States and allied interest.

On the opposite side of the ledger, we agreed to divest Aviation & Missile Solutions LLC, a small CEDAR [Phonetic] business within Dynetics. This divestiture allows us to focus on leading-edge and technologically-advanced services, solutions and products that are more in our sweet spot.

In 2021, we put $270 million towards repurchasing our shares. Looking ahead, our Board of Directors authorized a new share repurchase program of up to 20 million shares, replacing the prior authorization. We only had 4.5 million shares remaining on our $20 million share authorization from 2018 and we thought it prudent to increase our buyback capability.

Under the authorization, we can repurchase shares in the open market or through privately-negotiated transactions, including accelerated share repurchase transactions. Based on the current valuation of our stock, our financial outlook, our liquidity, our view of the M&A market and a consistent operating environment, we expect to be more aggressive on buybacks in 2022, and Chris will provide more color on that shortly.

Number three, in business development, the December quarter is seasonally -- is the seasonally weakest for our industry. Still, we achieved net bookings of $3.2 billion in the quarter, representing a book-to-bill ratio of 0.9. Importantly, about half of the awards were for new work. For the year, we booked $15.5 billion of awards for a book-to-bill ratio of 1.1. Our bookings don't include anything for the roughly $4 billion of protested awards we've been tracking, although earlier this month, we received positive developments on two of them. The FAA reawarded us our incumbent work modernizing the national aerospace system and GAO denied the protest of our takeaway of the NASA networking communications program known as AEGIS. We're still awaiting word on whether either firm continues to object.

Total backlog at the end of the quarter stood at $34.5 billion, which doesn't include any future task orders for many of our large single award IDIQs, like NGEN. With total backlog almost 2.5 times our 2022 revenue, we have a strong foundation for growth.

In the fourth quarter, we had large awards in each sector, including ISR support for the Air Combat Command in defense, operational support to a publicly-traded utility and R&D support to the National Energy Technology Laboratory in Civil and IT support to the Federal Parent Locator Service in health.

I want to focus on another award that speaks to what makes Dynetics so attractive to us. Our Dynetics subsidiary was awarded a 6-year $479 million cost plus fixed fee contract to develop Hypersonic Thermal Protection System prototypes for the U.S. Army's Rapid Capabilities and Critical Technologies Office.

Under the contract, Dynetics will also support materials research, novel inspection and acceptance efforts. The thermal protection system shields elements of the long-range hypersonic weapon system and the Navy conventional prompt strike system from extreme environments seen during flight. The Army and Navy working jointly have made hypersonic weapons their top priority, and this program is just one of the ways that we're supporting the broader hypersonic program. We're also the prime contractor for the common hypersonic glide body weapon and a key subcontractor for the long-range hypersonic weapon system. These programs are well funded and Dynetics is right at the center of them.

Number four, our ability to recruit, retain, motivate and grow our people is critical to our success. We were relatively flat from a headcount standpoint in the quarter, but were up 11% for the year. As tough as this year has been for our customers and the market, it's been just as tough for our people.

I would like to take a moment to thank the 43,000 Leidos employees for their unwavering commitment and collaboration in light of COVID challenges. We asked a lot of them and they truly delivered, whether executing a complex NGEN transition three months ahead of plan or successfully delivering the MHS GENESIS electronic health record system to an additional 10,000 clinicians and providers as part of its largest wave deployment to date, our teams have put mission first and delivery for our customers.

One of the ways that we support our people is through a company culture that fosters a sense of belonging, welcomes all perspectives and contributions and provides equitable access to opportunities and resources for everyone. Inclusion and integrity are intrinsically linked by the responsibility to respect yourself and others.

Our employees are empowered to uphold our values, creating a culture that we are incredibly proud of and that makes Leidos unique. We're committed to continued transparency in how we're doing from a diversity standpoint as well as making the lives of our employees and their communities better. For the first time, we'll publish our consolidated EEO-1 report on our website, which includes detailed information regarding workforce diversity, so we can chart our progress on the journey.

Before turning it over to Chris, I'd like to address the current budget environment. Since the Q3 call, Congress passed the fiscal year 2022 National Defense Authorization Act and President Biden signed the bill into law. The NDAA legislation authorizes approximately $740 billion for defense programs, a $25 billion increase to last year and well above the original presidential request.

Bipartisan leadership of the House and Senate appropriations panels reached an agreement on February 9 on the fiscal year 2022 top line spending numbers for defense and non-defense programs. Spending levels won't be publicly announced until after the Senate passes another CR. However, it appears there will be an increase for defense accounts and a slightly larger increase for non-defense accounts.

Ultimately, 12 appropriation bills will be packaged into a single omnibus bill for floor consideration. We are hopeful that the omnibus will be brought to the floor by March 8,so the President can approve it -- so it can be approved by the Senate and then signed by the President before the March 11 CR deadline.

With that, I'll now turn the call over to Chris Cage for more details on our results and our 2022 outlook.

Chris Cage
Chief Financial Officer at Leidos

Thanks, Roger, and thanks to everyone for joining us today. With lots to cover, let's jump right into the results, beginning with the income statement on Slide 5. Revenues for the quarter were $3.49 billion, up 7% compared to the prior year quarter. Excluding acquired revenues of $52 million, revenues increased 6% organically. For the year, revenues were $13.74 billion, which was up 12% in total and 9% organically compared to 2020.

In the quarter, we saw a continuation of the behavior that we cited on our Q3 call, where some customers, especially in the defense and intelligence sectors, worried about the extended CR and held back on funding. This was exacerbated by the limited ability to meet with customers with the onset of the Omicron variant and lower-than-anticipated direct labor given higher-than-normal paid time off usage by employees on cost reimbursable contracts. These factors led to revenues in the lower half of the guidance range that we gave on the last call.

Turning to earnings. Adjusted EBITDA was $359 million for the fourth quarter for an adjusted EBITDA margin of 10.3%. Margins were down sequentially and year-over-year, consistent with our prior messaging, although higher-than-normal leave-taking and lower-than-normal net favorable impacts from EACs lowered margins 20 basis points to 30 basis points below our expectations. For the year, adjusted EBITDA was $1.51 billion, which was up 14% over fiscal year 2020. Adjusted EBITDA margin of 11% was an improvement of 20 basis points over 2020.

In 2021, we benefited from a $26 million gain related to the Mission Support Alliance joint venture recorded in the first quarter and the backlog of disability exam cases that were pushed from 2020 to 2021 because of COVID. These two items added 60 basis points to the 2021 adjusted EBITDA margin.

Non-GAAP net income was $224 million for the quarter and $952 million for the year, which generated non-GAAP diluted EPS of $1.56 for the quarter and $6.62 for the year. For the year, non-GAAP net income and non-GAAP diluted EPS were up 13% and 14%, respectively, compared to fiscal year 2020. EPS growth benefited from a reduction of about 2 million shares from repurchases during the year. The non-GAAP effective tax rate came in at 22.4% for the year, which was in line with expectations.

Now for an overview of our segment results and key drivers on Slide 6. Q4 defense solutions revenues of $2.06 billion increased by 7% compared to the prior year quarter. Excluding the acquisitions of 1901 Group, Gibbs & Cox and a small strategic acquisition, defense solutions revenue were up 4% organically. The largest growth driver was the NGEN SMIT ramp, which more than offset the completion of the human landing system-based contract within Dynetics and the program supporting operations in Afghanistan. For the full year, defense solutions revenues were $8.03 billion, an increase of 9% in total and 6% organically.

Civil revenues were $800 million in the quarter compared to $811 million the prior year quarter, down 1% in total and organically. In the quarter, lower deliveries of security products outweighed increased demand on existing programs with commercial energy providers, the FAA and the National Science Foundation and the transfer of a small number of programs from the defense solutions segment. For the year, civil revenues increased from $2.99 billion in 2020 to $3.16 billion, driven by on-contract growth across many programs and a full year of contribution from the L3Harris Technologies Security Detection and Automation business acquisition.

Health revenues were $630 million for the quarter, an increase of 23% compared to the prior year quarter, and all of that growth was organic. The largest year-over-year increase was in the disability examination business, with the Military and Family Life Counseling program and DHMSM up nicely as well. As we previewed on the last call, fourth quarter revenues for the Health segment were down from the third quarter as we completed the backlog of cases from 2020. Health revenues were $2.55 billion for the year, up 30% over 2020 with the same drivers that I cited for the quarter.

On the margin front, on Slide 7, defense solutions margins were relatively stable. Non-GAAP operating margin came in at 8.2% for the quarter compared to 8.9% in the prior year quarter and 8.6% for the year compared to 8.2% in 2020.

Civil non-GAAP operating margin for the quarter was 10%, which was up sequentially, but down from 12.3% in the prior year quarter. Civil non-GAAP operating margin for the year was 10.2% compared to 11.7% in the prior year. Declines in segment profitability for the quarter and year were primarily attributable to lower volumes of security product deliveries.

Health non-GAAP operating margin for the quarter decreased from 18.5% in the prior year quarter to 17.8% primarily from investments to enhance long-term program execution. Health non-GAAP operating margin for the year increased from 14.4% in fiscal year 2020 to 18.8%, primarily from increased volume on fixed unit price programs.

Turning now to cash flow and the balance sheet on Slide 8. Operating cash flow for the quarter was $210 million, and free cash flow, which is net of capital expenditures, was $177 million. This was exceptional performance across every segment and enabled us to close out the year with operating cash flow of $1.03 billion, well above our guidance threshold of $875 million. Free cash flow for the year was $927 million for a 98% conversion rate. Without the $62 million headwind from the CARES Act tax deferral, we would have exceeded our 100% conversion target for the fourth straight year.

As we close out the year, we remain committed to a target leverage ratio of 3 times. Our long-term, balanced capital deployment strategy remains the same and consists 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.

On now to the forward outlook on Slide 9. Before commenting on 2022, let me first close out the financial projections we gave at our 2019 Investor Day. FY '21 marked the end of a three-year forecast period, and we exceeded or achieved all of our financial targets. Over the period, we grew organically at a compound annual growth rate of 7% versus a 5% target, achieved an adjusted EBITDA margin of 10.8% versus a 10% or greater target and converted 116% of adjusted net income into free cash flow above our 100% or greater target.

As we look towards 2022, there are some important factors to consider. There is no guarantee that we'll get an omnibus spending bill in February; the continuing impacts of COVID are unknown, and it's likely that Omicron won't be the last coronavirus variant; we can't be sure how long it will take to get our two large takeaway awards through the protest cycle; and we should expect that the large awards that we will receive this year will be delayed through protest. We want to take a measured, balanced approach to guidance, recognizing that there are significant outside forces to contend with.

With that, let's walk through the drivers for each metric. We expect revenues between $13.9 billion and $14.3 billion, reflecting growth in the range of 1% to 4% over fiscal year 2021. This growth would almost entirely be organic when balancing the remaining revenues from 2021 acquisitions with the divestiture that Roger mentioned.

To put that growth into context, let's consider the puts and takes moving from 2021 to 2022. On the positive side, we have NGEN and some other wins that are still ramping that provide good visibility into the upside. On the negative side, we have about $160 million of headwind from the Afghanistan drawdown, about $80 million reduction in disability exam volume and another $80 million from the human landing system program. These were all known and discussed as of the Q3 call.

Since then, a few additional headwinds have emerged. First, we were not awarded the follow-on to our NGA UFS work that was consolidated into the UDS procurement. UFS represented about $100 million of revenue in 2021 with the opportunity to more than double that amount if we had won UDS. In addition, the customer has recently notified us that they are not yet ready to complete the RHRP transition. This program should generate about $150 million of revenue a year and the start date has now been pushed from January until September. Finally, the multibillion-dollar FAA network procurement known as FENS has just been pushed from an expected award date in Q1 to at least Q4.

Moving on, we expect 2022 adjusted EBITDA margin between 10.3% and 10.5%. The midpoint of the margin range is the same as 2021 when you exclude the $26 million MSA gain and the extra disability exam case load. And the top end of the range is consistent with the target we laid out at our October Investor Day. We're committed to long-term margin expansion with multiple levers over time. We expect non-GAAP diluted earnings per share for the year between $6.10 and $6.50 on the basis of 142 million shares outstanding, which is unchanged from fourth quarter levels. Finally, we expect operating cash flow of at least $1 billion. This guidance incorporates the final $62 million repayment of the 2020 CARES Act payroll tax deferral.

As you're aware, there was a provision of the Tax Cuts and Jobs Act of 2017 that went into effect at the start of the year that requires us to capitalize and amortize research and development costs. Our operating cash flow guidance assumes that the provision will be deferred, modified or repealed. We currently estimate the impact of the provision on fiscal year 2020 operating cash flow -- 2022 operating cash flow to be about $150 million.

Expanding on Rogers' capital allocation comments, we expect to deploy a significant portion of our operating cash flow towards share repurchases, assuming no unforeseen material developments in our operating environment. Depending upon the share price and timing of any repurchases, we currently estimate this could add $0.10 to $0.20 to 2022 non-GAAP EPS. The $6.10 to $6.50 range we provided does not account for any repurchases, and we'll update you all as we go through the year. Given the industry factors that we've addressed, we expect a slower start to the year with a sequential decline in revenues in Q1, which is normal for us. We expect both revenues and margins to build significantly throughout the year.

Now a couple of other comments to help you with modeling 2022. We expect net interest expense of approximately $190 million and a non-GAAP tax rate of about 23%. Capital expenditures are targeted at approximately $150 million or roughly 1% of revenues.

Before we open up for questions, I would like to comment on something you will see in our upcoming 10-K filing related to a portion of our business that conducts international operations. In late 2021, we discovered through our internal processes, activities by certain of our employees and third parties raising concerns that there may have been violations of our code of conduct and potentially applicable laws, including the FCPA. We're conducting an internal investigation led by an independent committee of our Board and have retained outside counsel to investigate. We voluntarily self-reported our investigation to the DOJ and SEC. Because the investigation is ongoing, we're not able to anticipate the ultimate outcome or impact.

As we look to 2022, we recognize the challenges but believe we're well positioned to navigate them. Ultimately, the issues facing our industry are transitory and what remain are urgent needs for our customers and a compelling value proposition that we can offer as the largest, most capable company in our industry. With that, I'll turn the call over to Rob so we can take some questions.


Questions and Answers

Operator

Thank you. We'll now be conducting the question-and-answer session. [Operator Instructions] Our first question comes from the line of Seth Seifman with J.P. Morgan. Please proceed with your questions.

Seth Seifman
Analyst at J.P. Morgan

Hey. Thanks very much, and good morning.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Hey, good morning, Seth.

Chris Cage
Chief Financial Officer at Leidos

Good morning,

Seth Seifman
Analyst at J.P. Morgan

Chris, I think if I caught the headwinds you mentioned, it probably -- it sounds like it adds up to maybe $450 million or so for 2022. And I guess if you could outline the places where you expect to be able to offset that, just given that, that by itself, it seems like a reasonable amount of headwind to overcome next year.

Chris Cage
Chief Financial Officer at Leidos

Sure, Seth. Thanks for the question. No, absolutely. I mean we're fortunate that going into the second year of the NGEN program, we have really strong visibility into how that program will continue to ramp up, and kudos to our team that's just done an excellent job getting that transitioned early and now we're starting to see some of the project work that follows on to that program as well. So that's certainly one catalyst. We previously talked about the Military and Family Life Counseling program continuing to ramp up as we transition forward.

Roger featured the thermal protection system program. There's several nice things going on within Dynetics that we're excited about, the IFPC program that we won in the third quarter, a thermal protection program. So those will both be transitioning into a growth mode. We had expected, obviously, we were hopeful RHRP would have been a big growth catalyst for us this year. We still expect it to be, but that's been pushed out for six months now.

And then ultimately, one of the other big swingers will be what happens with AEGIS. We've modeled AEGIS to come in later in the year because we're anticipating potentially further action by the incumbent to delay that award. If they don't, that potentially gives us upside on the revenue line. But that's how we've positioned it within the guidance that we provided today.

Seth Seifman
Analyst at J.P. Morgan

Okay. Great. Thanks. And then maybe just to dig in a little bit more. I know you guys don't guide by segment, but just for health, you talked about the $80 million exam headwind. But just if we thought about health at the overall level, just because it's been -- that piece of the business has been running so hot, just thinking about the -- even qualitative discussion about the overall level of growth or contraction in health and the level of margin pressure.

Chris Cage
Chief Financial Officer at Leidos

Well, as we said, we do expect to be able to continue to grow our health business. We have programs like DHMSM that continue to ramp up which gives us a nice visibility there. Ultimately, RHRP will be an important contributor. But the 2022 revenue and profitability for the segment is consistent with what we've been trying to position, which is we knew that margins would be coming down, we had talked about potentially in the mid-teen area, we're on track with that expectation. The COVID case backlog has been worked down, but that particular line of business still performs excellently, we're very pleased with their performance. And there's a number of other large opportunities in the pipeline. But given the timing that we've seen on how procurements have been delayed, we're just being cautious about when those procurements might come out and our ability to win those and begin to execute.

Seth Seifman
Analyst at J.P. Morgan

Great. Thank you very much.

Chris Cage
Chief Financial Officer at Leidos

Thank you.

Seth Seifman
Analyst at J.P. Morgan

All right.

Operator

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

Sheila Kahyaoglu
Analyst at Jefferies Financial Group

Good morning, Roger, Chris since --

Roger Krone
Chairman and Chief Executive Officer at Leidos

Good morning, Sheila.

Sheila Kahyaoglu
Analyst at Jefferies Financial Group

Seth asked about the margins, I might as well ask about the balance sheet then. You both mentioned more aggressive with share repurchases. Obviously, that's deviating a little bit from your M&A strategy. So how do you kind of think about that? And what's your appetite for larger deals?

Roger Krone
Chairman and Chief Executive Officer at Leidos

Hey, thanks, Sheila, and good morning. We're pretty transparent on the bigger deals. We're not really enthusiastic about what is out there. We -- and we talked about this before, of course, Sheila, is that we've done some major transactions over the past several years and we're now performing against those. And our M&A is really focused on adding capability or access to a new customer. And those tend to be smaller.

And barring something that really is transformative, our capital allocation is going to stay the way it has been, which is we invest in the company, we pay a dividend, we maintain our debt level and then we find a tax-efficient way to give the excess cash back to our shareholders. And of course, we've said some things this quarter that indicate that we have less need for that cash. So take that as you will, but we are such a great cash generator. Our ability year-over-year to raise the dividend, buy back shares, I think, is impressive, and we're just saying we believe that will continue in the future.

Sheila Kahyaoglu
Analyst at Jefferies Financial Group

And then maybe one on civil segment. I think it declined in the quarter, and it was one of the -- I think it was the lowest-growth segment in 2021, but it's unlike your Analyst Day end market outlook. So can you kind of talk about what drives the reacceleration of growth in Civil and kind of your expectations there for 2022?

Roger Krone
Chairman and Chief Executive Officer at Leidos

Well, I'll talk about a couple of things, and I'll let Chris follow. Civil is an area where protests and program delays really hurt us. We had a program named FILMS [Phonetic], which is in protest. AEGIS was in protest. The FENS program at one time could have been a '21 award, and we thought it was a first quarter '22 and now it looks like it's a third quarter '22.

So as we mentioned, both in my piece and in Chris', the delay of acquisitions have, I think, hurt the industry across the board. And for us, I think Civil took a major part of the brunt of that. But these -- by the way, these programs are still going to happen. And so we're enthusiastic about our competitive position. The customer just has to get them through the acquisition cycle and they've got to get awarded and then we've got to sort our way through the protest period. And we mentioned with AEGIS, we don't know what's going to happen to AEGIS. Some of that upside, maybe that will get resolved earlier. But if there's another round of protest at Court of Federal Claims, it could be somewhere again.

And then the Omicron variant kind of kept our security detection business sort of at nominative levels. We were hoping for a much stronger rebound in -- frankly, in air travel and leisure. And although we have seen a rebound, but nowhere near what we had hoped. And I don't know, here in D.C., we'll look like we'll come off the back of Omicron, we have our fingers crossed, but I've said that before, there could be another variant right behind it.

Chris Cage
Chief Financial Officer at Leidos

Yes. Sheila, the only thing I'd add, I mean Roger mentioned a few. We certainly continue to see a number of digital transformation, IT modernization opportunities within the civil customer set. And those tend to be bigger and they tend to take longer to get through a decision process, but we like that aspect of the pipeline. But he also mentioned SD&A, and that will continue to be something that we're assuming is not a growth catalyst in the near term but positioning that for '23 and beyond.

Sheila Kahyaoglu
Analyst at Jefferies Financial Group

Okay. Thank you.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Yes.

Operator

Next question comes from the line of Matt Akers with Wells Fargo. Please proceed with your questions.

Matt Akers
Analyst at Wells Fargo & Company

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

Roger Krone
Chairman and Chief Executive Officer at Leidos

Hey, good morning.

Chris Cage
Chief Financial Officer at Leidos

Good morning.

Matt Akers
Analyst at Wells Fargo & Company

I was wondering if you could comment on the long-term 5% to 6% organic growth target. And just if you could give us maybe sort of a walk of what are kind of the biggest things. I know you mentioned some of the -- I think at civil in the last question, but if you just can sort of kind of bridge the gap from '22 growth to where you think it will be longer term.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Well, I'll mention a couple of things and I'll let Chris add. But the defense enclave services, if you were around the office, you will know what we're talking about in the hallways, I mean we were right up against that award. And that's a -- it's just a large program, I can't underestimate how big that program is. And there's another competitor, and it's a very competitive program. And we're hoping that it will be a first quarter award with probably at least a 100-day protest, maybe more than that. And so that will start to ramp, assuming we win that later in the year.

And then Chris touched on a couple of things. RHRP will start ramping. We'll get a full year of maybe NextGen. So there's a lot that can happen for us that's very, very positive. But here we are in the first quarter frankly with a fair amount of uncertainty. And you saw where we are on the guide. It's a nice range on the guide. We're going to do everything we can to get to the high end of that. But with the CR and Omicron and Ukraine and everything else that's going on, we thought positioning ourselves where we did was the right thing to do.

Chris Cage
Chief Financial Officer at Leidos

That's right. Matt, just a couple other things I'd mention. Again, as we look towards that three-year time horizon, especially '23 and '24, I talked about a couple of the Dynetics programs, we continue to be excited about the positions on prototype programs that they're winning, which ultimately we have every expectation will turn into more full-scale production programs and those could be significant growth catalysts for those out years.

The return of the aviation screening market, again, cautious outlook in 2022, but we're several hundred million dollars below levels pre-pandemic for that combined business as far as the top line goes. So that could be a future growth catalyst area. And then Roger mentioned a couple of the big programs that we're tracking, whether it be DES or FENS, AEGIS, and there's many more in the pipeline.

So that's how we kind of think about it. There's several things that we anticipate over the course of this year will position us for accelerating our growth rate. But until we can bring those things in with more visibility, we'll be cautious on the near-term outlook.

Matt Akers
Analyst at Wells Fargo & Company

Great. Thanks. That's helpful. And I guess is there any more you can tell us on -- you mentioned the issue that you discovered late last year of potential FCPA violations. Is there anything more you can give us on the magnitude or when that might get resolved?

Roger Krone
Chairman and Chief Executive Officer at Leidos

Yes. We wish we could. But when you have these open investigations, we're really restrained on what we can tell you. So -- and I think Chris pretty much paraphrased the paragraphs you see in the litigation section in the K. But what we will tell you is when we have more to tell you, we'll let you know. But right now, it's an open investigation and we're proceeding. And sometime in the future, we'll have more to say.

Matt Akers
Analyst at Wells Fargo & Company

Understood. Thanks.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Yes.

Operator

Our next question comes from the line of Gavin Parsons with Goldman Sachs. Please proceed with your questions.

Gavin Parsons
Analyst at The Goldman Sachs Group

Hey. Good morning.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Hey. Good morning, Gavin.

Chris Cage
Chief Financial Officer at Leidos

Good morning, Gavin.

Gavin Parsons
Analyst at The Goldman Sachs Group

Chris, I appreciate all the color on the revenue bridge on the headwinds and tailwinds. Could you help us quantify the impact this year of, assume full quarter of a CR, the procurement delays, the COVID-related utilization, any of those other headwinds that aren't the program-specific numbers you just gave us?

Chris Cage
Chief Financial Officer at Leidos

Well, it's all kind of tied in. As we thought about that, we took a view of when decisions might be made on some of the new programs that we're chasing and also kind of really layering in what we saw in the third and fourth quarter as far as lower-than-normal activity on kind of on-contract growth activity, Matt -- or Gavin. So again, it's more of a point-by-point as we thought through our pipeline and award timing and decisions. But obviously, where we position kind of the midpoint of the growth, all those things considered, shaved a couple of points off of where we ordinarily might have been.

Gavin Parsons
Analyst at The Goldman Sachs Group

Got it. So then maybe to Roger, how do you think about the level of conservatism that, that does encapsulate kind of given how unpredictable a lot of these headwinds have been, but it also sounds like maybe you're assuming some contribution from DES, which could be a coin flip. So how are you thinking about the level of conservatism that you've baked in here?

Roger Krone
Chairman and Chief Executive Officer at Leidos

Well, we really want -- especially with everything that's going on this year, we want to be in a really balanced position here in the first quarter. And then as these decisions, we need to get an omnibus, we need to get some of these programs awarded, as we can release that risk, then -- your words, not mine, conservatism, I would rather call it balance, we can rebalance where we are throughout the year. And there are just so many multi-billion-dollar opportunities ahead of us that with potential for another COVID variant, I think we're going to get an omnibus. But if not, I mean, there's still people in Washington saying there could be a potential government shutdown. And here we are, and we haven't even had the State of the Union or the skinny budget by the President. So there's a lot of uncertainty here in D.C. if you listen to radio. And so we just want to be in a position where we've got a good range, and we can work away up in the range as these risk items get released.

Gavin Parsons
Analyst at The Goldman Sachs Group

Got it. I appreciate it. And a quick clarification to just Matt's question. Is 5% to 6% still the right three-year range? Or should we think of this year as normally disrupted and it's 5% to 6% after '22?

Chris Cage
Chief Financial Officer at Leidos

Yes. We haven't -- Gavin, at this point in time, we're not changing kind of that three-year CAGR outlook, right? There's lower starting point than we had anticipated given the dynamics that have played out over the last couple of months, but as we pointed to many paths to continue to get there and as we resolve some of these major swingers such as DES and others in the near term, hopefully, we'll be able to give you more clarification on that three-year outlook.

Gavin Parsons
Analyst at The Goldman Sachs Group

Got it. Thank you.

Operator

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

Robert Spingarn
Analyst at Melius Research

Hi, good morning.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Good morning.

Chris Cage
Chief Financial Officer at Leidos

Good morning, Robert.

Robert Spingarn
Analyst at Melius Research

So yes, I don't know if Roger or Chris, which one of you want to take this, but we talked about '22 being a bit of a transitionary year from a revenue perspective. I wanted to try, with COVID lingering and the CR going into March, I wanted to ask the question from a margin perspective. And you've got civil, which improved a little sequentially, but it's still down on the security detection. How do you think about the segment margins in '22? And how does that compare to normal?

Chris Cage
Chief Financial Officer at Leidos

Well, I'll start and Roger might have some thoughts here, too, Robert. I would say that we've been signaling for some time now that health was running at an elevated level and that was going to moderate down. And I'll tell you that the conversations we've been having internal to the business around the other lines of business have been around margin expansion opportunities and where are those going to come from and what actions are we taking. And so as we built our 2022, we're finding opportunities and challenging the business leaders to drive margin expansion across their portfolios. And we're doing that in a thoughtful and balanced way, but have good confidence on the levers to pull to make that a reality over time. So I think that's what you should continue to see, is a little bit more rebalancing of the margins across the portfolio and then getting the health group to a position that is stable, that we can grow off of there. And so that's the way '22 should play out for you as far as margins go.

Roger Krone
Chairman and Chief Executive Officer at Leidos

And Rob -- go ahead and ask your question.

Robert Spingarn
Analyst at Melius Research

I didn't want to interrupt you, Roger.

Roger Krone
Chairman and Chief Executive Officer at Leidos

No, Rob, I don't want to interrupt you.

Robert Spingarn
Analyst at Melius Research

Well, longer term, getting back to like an 11% type of number, what time frame should that be?

Chris Cage
Chief Financial Officer at Leidos

Well, for civil, if you're talking about civil specifically, I mean, it gets to 11% if there's a significant rebound across our aviation screening market, right? That's critical to that portfolio, and that's an above-average margin piece of the portfolio, the volume needs to increase there. As we've signaled, we're hopeful, at this point in time, we'll see that continuing to get to those levels starting in 2023 and growing from there. But the core aspects of the portfolio wouldn't be 11% without a decent contribution across the security products business.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Hey, Rob.

Robert Spingarn
Analyst at Melius Research

Yes.

Roger Krone
Chairman and Chief Executive Officer at Leidos

I'll make the point that I was going to make earlier. You raise margin in our business, really two ways, right, through operating performance, being more efficient, scale, being able to spend less capital, less R&D, less marketing because you have size, right? And we've been on that journey, and you've seen some real benefits from that.

The other way you can raise margin in our business is you change your mix, right? We don't bid on relatively low LPTA 3% bids, and we bid on highly value-added differentiated programs like the thermal protection system. But if you've got a contract that's four or five years to support a mission where you're doing maintenance operations and maintenance work, those things have to roll off so the portfolio mix doesn't change as quickly as perhaps you would like or perhaps our investors would like. And by the way, those are good contracts and they generate a lot of cash and they help us build relationships with customers.

So we have been moving over time really on both fronts, operating better, being more efficient, using our discretionary funds better, but also, if you will, moving up on the value chain and bidding on more differentiated work and then shying away from things that are LPTA and more commodity.

Robert Spingarn
Analyst at Melius Research

Okay. And Chris, when I mentioned the 11%, I was thinking enterprise-wide, just --

Chris Cage
Chief Financial Officer at Leidos

Yes, Rob, well, you're challenging me today then on 11% for the enterprise, well, that was a great year last year, as we pointed to. 60 basis points came from a couple of items that aren't going to repeat. We signaled 10.5% as our long-term target at Investor Day. Again, our expectation is to get to that level and then -- and we do believe, as Roger pointed out, depending upon the mix in the portfolio, continuing to pursue areas, contracts, work areas that will give us margin expansion opportunities from there.

Robert Spingarn
Analyst at Melius Research

Got it. Got it. Thank you, both.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Thank you.

Chris Cage
Chief Financial Officer at Leidos

Thanks, Rob.

Operator

The next question comes from the line of Colin Canfield with Barclays. Please proceed with your questions.

Colin Canfield
Analyst at Barclays

Hey. Good morning, guys. Thanks for the question. So just a follow-up first on Matt and Gavin's question. With respect to the headcount growth and kind of your organic targets that are applying FY '23, FY '24 of mid-single digit to high single digit, can you just talk us about -- talk to us about the headcount growth assumed in getting into that accelerated organic growth rate?

Roger Krone
Chairman and Chief Executive Officer at Leidos

Well, yes, I mean, we can. Let's see, we don't really put out numbers. But we obviously have to add heads. We're at about nominally 43,000. The exact number will be in the K. Maybe just a little short of 43,000 by like 20 or 30. And we have to add a significant number of people in the thousands, again, without putting out a specific number. And I think your question is really more of the risk around being able to continue to attract people to the company. And we -- that's something actually, as a leadership team, we look at literally every week. And when you look at the number of people that we've hired and the people who have left, either the great resignation who have left the industry or retired or the people that have gone to competitors. And we are still comfortable with our ability to attract and retain the workforce that we need.

The other question we usually get is about wage inflation, and I'll just hit that one, is that we have seen a little bit of uptick in what we're paying people. It's all based in our numbers and our guidance. But we're also seeing the opportunity to hire some college grads at a lower wage rate. And frankly, some of the skills we need are coming right out of college, like Python programming language. And so that allows us to bring in some earlier career people into our cost structure which has a beneficial effect. So we always say that the workforce is a risk item for us, but we've been fortunate to create a company and a culture where people want to come to work. And we -- frankly, our first six weeks of the year have been pretty impressive on the hiring that we've already done in 2022.

Chris Cage
Chief Financial Officer at Leidos

Colin, the only thing I would add to Roger's comment, and he's right, it is thousands of employees, but it's not -- doesn't have to grow at the same rate as revenue because some of the things we pointed to for the '23 and '24 catalysts are going to come more on the manufacturing product side, those production programs in Dynetics and the return of the SD&A business market that we expect. Those don't require the same level of headcount growth contributions to drive that revenue uplift. So it's a big challenge, we're focused on it, but it's not a one-for-one relationship to get to the outcome.

Colin Canfield
Analyst at Barclays

And then with respect to the margin question, kind of following up to Rob's vein of thinking, both you and CACI are assuming that you can mix shift kind of into better work. Can you just talk us about what sort of competitive win rate you're assuming on hardware-type contracts and kind of where Leidos competes on price versus capability?

Roger Krone
Chairman and Chief Executive Officer at Leidos

Let's see. I'm not sure I even know the number on hardware versus digital transformation. I'll describe just a little bit. The acquisition process for us on hardware is very, very different than, say, some of our large digital transformation opportunities. The large digital transformations are a lot of bidders, RFP process, draft RFP, competitive bid, maybe down-selected to then a competitive bid.

On the hardware side, it starts with spending our own R&D to create a concept and investing in a prototype or a demo or a simulation and then maybe getting a CRADA, like a cooperative research program where we take it out in the field and we shoot a prototype and we get a customer interested in it. And eventually that leads to a limited production order, which can actually lead to a large production order.

So for us, I can't speak to the other people in our industry, in the areas where we compete, we're really competing off of differentiated technology that we've developed. Very rarely are we taking our widget against somebody else's widget and a third-party's widget and we're fighting it out in the proposal process which, again, is typically in our large digital transformation jobs, how we win there. And it's why we like some of this in our mix. If you followed our story over the long term, we've said we would like a little bit more product, a little bit more hardware, where we can invest in a differentiation and then we can reap the benefits of that over the long term.

Chris Cage
Chief Financial Officer at Leidos

The only other thing I'd add there, Colin, is on the differentiation front, the other attribute that allows us to be successful is speed. And we've talked about that, but we're more nimble, we're more agile. And so sometimes as we're looking at positioning for emerging capabilities, our ability to get that delivered and fielded more quickly, because we can respond more quickly, is a characteristic that allows us to be successful.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Yes. Just an example there, because you can tell that we're really excited about this part of our business. We had a customer who needed an airborne asset. And we went from concept to delivery within 12 months. So we bought the airplane, we wanted the airplane, we put equipment in, the customer gave us some GFE, we went through a test program, we got and fielded within 12 months. And that speed, security and scale, we think, is one of our differentiators.

Operator

Thank you. The next question comes from the line of Mariana Perez Mora of Bank of America. Please proceed with your question.

Mariana Perez Mora
Analyst at Bank of America

Good morning, everyone.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Good morning.

Mariana Perez Mora
Analyst at Bank of America

So 1% to 4% organic growth. What makes you confident that this is just a slow start and you could get to the mid-single digits growth in the next three years and this is not a new normal from a macro environment? So in other words, given this uncertain environment, why not under promise and over deliver?

Chris Cage
Chief Financial Officer at Leidos

Well, we're only giving '22 guidance today, right? And so we're trying to make sure that based on the factors we've seen, Mariana, over the last four months, it reflects those challenges that we see. But at the same time, we also see these needs and these opportunities in the pipeline. And so as we sit here today, we look at where our customer is going and the things that we think ultimately they will be buying and the demands that they have and the funding levels that we believe will be there still give us the ability to achieve that longer-term aspiration that we have for growth. But for right now, '22, you're right, it is a little bit more of a cautious start given the uncertainty in the environment today. But we try to paint a picture of how that could increase our growth rate over time, depending upon how some of these uncertainties resolve themselves.

Roger Krone
Chairman and Chief Executive Officer at Leidos

Yes. And Mariana, we've talked about this in the past, is we have been trying to position the company to where we think the puck will be in the future. So -- and as we look at the omnibus, we think there's going to be an even greater growth in non-defense. So that will benefit us in our health and civil business, which we have bolstered over the past several years. And then within defense, the shift to great power competition, which we think benefits things like space and hypersonics and electronic warfare, again, areas that we have been positioning now for years. And so we're enthusiastic about the long term. In first quarter of 2022, there's just a lot of risk that needs to be retired which is why we are where we are.

Mariana Perez Mora
Analyst at Bank of America

Thank you. And then could you please discuss on competitive dynamics, hard win rates and pricing pressure being affected as new industry players are also doing the scale and sculpt strategy?

Chris Cage
Chief Financial Officer at Leidos

Competitive dynamics, so I would say that it's the same competitors that we go up against typically. And we're -- we have a great team that are leading our business development, great capture managers, a good price to win team. We think we have a good pulse on what each procurement competitive set looks like. And so each one is different. To Roger's earlier point, we do try to steer away early in the process in our pipeline of things that we believe are only going to be based upon a price-oriented decision. That's not where we want to compete.

But clearly, I mean, the market is always competitive and we approach it that way. So there's no different -- we're not taking our eye off the ball, we always go after everything, anticipating that it's going to be highly competitive, we need to put our best foot forward. And so that's the way we've been prosecuting the bids in our pipeline.

Mariana Perez Mora
Analyst at Bank of America

Thank you very much.

Roger Krone
Chairman and Chief Executive Officer at Leidos

And Rob, it looks like we're coming up to the top of the hour, I think we have time for one more question.

Operator

Yes, that question will be coming from the line of Tobey Sommer with Truist Securities.

Tobey Sommer
Analyst at Truist Securities

I was wondering if you could give us a perspective on the proportion of your business up for recompete this year and next and how that may inform the aperture that you have in your business development pipeline to look for new and takeaway work.

Chris Cage
Chief Financial Officer at Leidos

Hey, Tobey, this is Chris, and Roger can add some more color. I would say it's actually a lower-than-normal year in '22, and so that kind of informs our internal goal on what we think our book-to-bill needs to be and what our target is. So absolutely, it's an increased percentage of takeaway and new business opportunities that we're going after. And that comes with lower expected win rates. So we have to be very thoughtful about the volume that we're prosecuting through. And certainly, we don't take our eye off the ball on any recompetes and put our best foot forward. But it is a lower-than-average year, which is great. So we're definitely more on the attack in '22 than we might ordinarily be.

Tobey Sommer
Analyst at Truist Securities

Would that hold true for '23 as well?

Chris Cage
Chief Financial Officer at Leidos

I would tell you that we haven't probably broken that down with great visibility yet. I mean there is not one of our top 10 programs that come to mind that are coming up for a recompete cycle next year. So -- but more color on that as we get our way through the year, Tobey.

Tobey Sommer
Analyst at Truist Securities

Okay. Thank you.

Chris Cage
Chief Financial Officer at Leidos

Thank you.

Operator

Thank you. I will now turn the floor back to management for closing remarks.

Stuart Davis
Senior Vice President, Investor Relations at Leidos

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

[Operator Closing Remarks]

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