Leidos Q1 2022 Earnings Call Transcript

Quartr
Provided by Quartr
May 3, 2022

There are 12 speakers on the call.

Operator

Greetings. Welcome to Leidos First Quarter 2022 Earnings Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded.

Operator

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

Speaker 1

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our Q1 Fiscal Year 2022 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'll 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.

Speaker 1

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

Speaker 2

Thank

Speaker 3

you, Stuart, and thank you all for joining us this morning. Our Q1 marked a strong start to 2022 With record levels of revenue, backlog and backlog stemming from our leadership position in the government technology market, We continue to build our reputation and track record of performance in digital technology, cyber and innovative systems across our diversified Resilient Business Portfolio. Our strong first quarter results and the improving federal budget picture Increase our confidence in delivering on our full year financial commitments. I'll organize my remarks around 4 messages. First, our financial results demonstrate our ability to meet our commitments and outperform the market.

Speaker 3

2nd, our business development results are a testament to our differentiated position in the market. 3rd, Our consistent capital allocation approach drives shareholder value. And 4th, we're able to attract the workforce We need and develop them for long term success. Number 1, our financial performance was strong at both the top and bottom lines. Revenues of $3,490,000,000 were up 5.4% in total And up 4.4 percent organically year over year, which is once again towards the top of the market.

Speaker 3

Non GAAP diluted EPS for the quarter was $1.58 with an adjusted EBITDA margin of 10.2%. All three metrics were ahead of our plan for the quarter. Finally, we generated $93,000,000 of cash flow from operations And free cash flow of $65,000,000 We remain on track to generate more than $1,000,000,000 of operating cash flow this year. Number 2, business development sustained the momentum that drove our industry leading organic growth last year. We achieved net bookings of $5,400,000,000 in the quarter, representing a book to bill ratio of 1.6.

Speaker 3

As a result, total backlog at the end of the quarter stood at a record $36,300,000,000 which was up 11.6% year over year. The awards in the quarter were rich in new business and takeaways balanced across our 3 segments and concentrated in key capability areas, including digital transformation and cyber. In Civil, 2 large awards successfully completed lengthy protests. We won the $2,500,000,000 10 year Advanced Enterprise Global Information Technology Solutions or Aegis program, where we'll provide communication, data center cloud And cybersecurity services across all of NASA's centers and facilities. For the FAA, We'll continue our more than 20 years of support on the National Aerospace Systems Integration support contract.

Speaker 3

The new NISC Contract is a single award IDIQ with a $1,700,000,000 ceiling across 10 years. Our work encompasses strategic and transition planning, flight procedures, security and safety, data analytics And unmanned aircraft systems in support of air traffic control modernization efforts. In health, we won 2 multiple award IDIQs totaling about 1,700,000,000 Over 6.5 years to provide disability examinations for the Veterans Benefits Administration. The first was a recompete for pre discharge exams in the United States, and the second is a new area for us, Exams outside the United States. Although we'll have more competition within our legacy business, we're excited about the opportunity to expand internationally.

Speaker 3

In Defense Solutions, our Gibbs and Cox subsidiary won a 3 $1,000,000 5 year award for ship design engineering services for the U. S. Navy's Future Service Combatant Program. We won 2 new cyber programs totaling $340,000,000 focusing on agile secured DevOps, Cyber inspection and assessment, continuous monitoring and audit and security management services. We also had a takeaway win on $100,000,000 single award IDIQ to modernize the Army's Gunnery training simulation systems.

Speaker 3

This work serves to enhance readiness across the operational spectrum in support of National Defense. And the biggest, most impactful win for the quarter is not included in our bookings. We were awarded the $11,500,000,000 Defense Enclave Services contract by the Defense Information Systems Agency. The DES contract is a 10 year digital modernization program focused on consolidating common IT services Into a single service provider framework. As expected, this award is now in protest With the GAO scheduled to decide in mid June.

Speaker 3

One of the keys to our BD success is our strategic partnerships, including with Amazon Web Services. I am proud that Leidos was awarded the AWS 2021 Public Sector Consulting Partner of the Year. AWS recognized Leidos with this honor Because of our deep technical partnerships in areas such as edge to cloud and next generation digital infrastructures to build solutions that drive digital and cloud transformation. This recognition illustrates the value Of the Leidos Alliance Partner Network, which we founded in 2018 to deepen relationships With the most important vendor partners across our business groups. This network has fostered greater collaboration With partners to drive technology innovations and continues to be a differentiator for Leidos on a wide range of proposals and programs.

Speaker 3

Number 3, I view capital allocation as one of the keys to creating shareholder value. Last quarter, we talked about a greater focus in 2022 on share repurchase, and we followed through with a 500,000,000 Accelerated share repurchase. We sit near our target leverage ratio and our ability to generate cash Gives us significant firepower for further capital deployment. We're well positioned to grow, and we'll continue to look for technology add ons and strategic initiatives that bring us differentiated capabilities for customer access. We'll pursue large M and A only for a company that truly accelerates our strategy.

Speaker 3

Number 4, People are at the heart of what we do. In this quarter, we hired more than 2,600 people. One reason people are attracted to Leidos is that we enable our employees to build successful careers. We regularly review talent and planned development actions at all levels of the company. This quarter, we made several key moves at the executive leadership team and Board levels.

Speaker 3

We're pleased to welcome our new Chief Human Resources Officer, Maureen Watterson, who brings an impressive background and skill set To the Leidos team, her excitement and commitment will enhance our people experience here at Leidos. With about 1600 funded vacancies and an industry wide shortage of cleared technical talent, recruiting and retention remains Areas of strategic focus. Maureen will lead our human capital strategy and continue shaping the employee journey at Leidos Through our Leidos Life initiative, Dave King has decided to step back from his role as Dynetics Group President. He will continue in a consulting capacity, ensuring a smooth change to new leadership and on matters of strategic importance. I want to thank Dave for his outstanding contributions thus far, And I look forward to working with him in his new capacity.

Speaker 3

Dave's Deputy, Steve Cook, is stepping up as DyneDEX Group President. Steve's extensive experience and background, both with Dynetics for 13 years And leading critical programs for NASA before that have prepared him well for his new role. He'll team with Paul Angola as his deputy. In addition, Paul will lead the National Security Space Business for Leidos with a focus on space surveillance, missile warning and space situation awareness. Next, Our digital modernization business is growing rapidly with an expanding portfolio of differentiated technology.

Speaker 3

To meet the demands of our growing business, Steve Hull will move from his role as CIO to lead the Enterprise and Cyber Solutions operation Within the Defense Group, we've moved our CIO team under Chief Technology Officer, Jim Carlini, To tightly align our technology and CIO capabilities. Finally, Pat Shanahan Has joined our Board of Directors. He served at the highest levels of government, including Deputy Secretary of Defense and Acting Secretary of Defense and Industry, including more than 30 years with Boeing, where he led Supply Chain and Operations, Commercial Airplane Programs and many other relevant areas. While at DoD, he was a passionate champion of digital and technological advancement for the department, driving modernization in cybersecurity, AI and cloud computing, as well as command, control and communication. Pat's wealth of expertise offers tremendous benefits For our shareholders and customers, before turning the call over to Chris, I'd like to address the current congressional budget environment.

Speaker 3

Since the Q4 call, Congress passed the fiscal year 2022 omnibus spending package, funding the federal government The remainder of the fiscal year with $782,000,000,000 in defense spending, a 5.6% increase From fiscal year 2021 $730,000,000,000 in non defense spending, a 6.7% increase from fiscal year 'twenty one. The budget also includes $14,000,000,000 in emergency supplemental spending in support of Ukraine given the devastation at the hands of the Russians. It will take I'm for the new budgets to work their way individual programs and new opportunities, but this provides positive momentum for the back half of twenty twenty two and into 2023. President Biden has also released his 5,800,000,000,000 fiscal year 2023 budget request. This request includes $813,000,000,000 in defense spending $769,000,000,000 in non defense spending.

Speaker 3

In addition to kicking off the fiscal year 'twenty three congressional budget process, Congress remains focused On finalizing a $10,000,000,000 bipartisan COVID-nineteen relief measure and passing legislation to increase American competitiveness with China. Congress also continues to grapple with rising inflation rates, In closing, our thoughts are with the people of Ukraine and our colleagues who have family and friends in the country. The United Nations estimates that more than 11,000,000 people are displaced. To help those impacted, We've made a significant donation to Project Hope to mobilize emergency teams and send medical supplies. The people of Ukraine have lost infrastructure that will take lifetimes to replace.

Speaker 3

When the war ends, it will only be the beginning of their struggle. I'll now turn the call over to Chris Cage.

Speaker 2

Thanks, Roger, and thanks to everyone for joining us today. As Roger said, Q1 was an outstanding quarter across the board, and I'm proud of the team for delivering such strong operating performance. Let's jump right into the Q1 results, beginning with the income statement on Slide 5. Revenues for the quarter were $3,490,000,000 up 5.4% compared to the prior year quarter. Revenues grew organically across all three reportable segments given robust Hiring and high labor utilization.

Speaker 2

Adjusted EBITDA was $358,000,000 for the Q1, which was down 8% year over year Adjusted EBITDA margin decreased from 11.7% to 10.2% over the same period. Adjusted EBITDA was down primarily as The result of the $26,000,000 net benefit related to the Mission Support Alliance joint venture recorded in the Q1 of fiscal year 2021, as well as a return to more normative indirect spending levels as we move past the pandemic. Non GAAP net income was $223,000,000 for the quarter, which was down 10.4 percent year over year and non GAAP diluted EPS for the quarter was 1 point percent compared to the Q1 of fiscal year 2021. Interest expense was up $3,000,000 year over year With the additional borrowing to fund the Gibson Cox acquisition and the $500,000,000 accelerated share repurchase, The non GAAP estimated tax rate was 21.2%, which was in line with our expectations for the quarter, but below the projected 23% for the year. The weighted average diluted share count for the quarter was 140,000,000 shares compared to 144,000,000 in the prior year quarter.

Speaker 2

Now for an overview of our segment results and key drivers on Slide 6. Defense Solutions revenues increased by 4.6% compared to the prior year quarter. The largest growth drivers were the NGEN and IPC ramps, which more than offset the completion of the Human Landing System base contract within Dynetics and the end of our Afghan support contracts. Defense Solutions non GAAP operating margin for the quarter came in at 8.1%, which was down compared to the prior year quarter as the result of higher investments on developmental programs. Civil revenues increased 3.8% compared to the prior year quarter.

Speaker 2

The revenue increase was primarily driven by volume growth on existing programs, including the support to Hanford and the FAA as well as our engineering support to commercial energy providers. Civil non GAAP operating income margin was 7.7% compared to 12% in the prior year quarter. The decline in segment profitability was primarily attributable to the MSA gain in the prior period as well as a write down taken on a minority interest joint venture program. Health revenues increased by 10% compared to the prior year quarter. We continue to benefit from the ramp on the Military and Family Life Counseling program and DHMSM had a large year over year increase based on deployment timing.

Speaker 2

Health non GAAP operating income margin was 19.2% compared to 18.6% in the prior year quarter. The improvement in segment profitability was primarily attributable to efficiencies introduced into procurement and delivery on certain contracts. As we've discussed previously, we expect Health segment margins to land in the mid teens for the year. Turning now to cash flow and the balance sheet on Slide 7. Operating cash flow for the quarter was $93,000,000 and free cash flow, which is net of capital expenditures, was 65,000,000 During the Q1, we returned $577,000,000 to shareholders, principally through the $500,000,000 accelerated share program that we put in place 2 days after our February earnings call.

Speaker 2

We were immediately able to retire 4,500,000 shares. The program will end within the next 2 weeks. And if our share price remains relatively constant, we'll retire another few 100,000 shares at that time. We're funding the ASR with a combination of cash on hand and proceeds from the issuance of commercial paper. When the Russians invaded Ukraine, The CP market became more volatile, so we sold some accounts receivable for short term liquidity.

Speaker 2

Since then, CP Markets have cleared and we've exited the AR monetization by quarter end, so there was no impact on cash flow for the quarter. At quarter end, we still had about $75,000,000 of borrowings outstanding through our commercial paper program. As of April 1, 2022, we had $297,000,000 in cash and cash equivalents and $5,100,000,000 of debt. 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 On now to the forward outlook.

Speaker 2

As shown on Slide 8, we're maintaining our guidance for fiscal year 2022. Specifically, we expect revenues between $13,900,000,000 $14,300,000,000 adjusted EBITDA margins between 10.3% 10.5 non GAAP diluted earnings per share between $6.10 $6.50 and cash from operations of $1,000,000,000 or greater. With 3 quarters to go, we believe the current ranges still encompass the likely outcomes for the year. That said, I'll offer a few comments to help with modeling. On last quarter's call, I mentioned a range of EPS benefits from share repurchases.

Speaker 2

When we were implementing the plan, our stock was trading in the mid-80s. We're now forecasting a volume weighted average share price of around $105 In addition, with world events, interest rates have risen and liquidity has tightened, which has increased borrowing costs. Given these factors, we're now projecting the addition From the Q1 ASR program to be closer to $0.10 than $0.20 In addition, we see the current environment is favorable towards growth, and we're exploring multiple opportunities where prudent investments could pay long term benefits to Leidos and our shareholders. These increased investments may come in business development, R and D and program execution. Finally, As Roger mentioned, we remain on track to generate $1,000,000,000 of operating cash flow.

Speaker 2

As is our usual pattern, we The lion's share of operating cash flow will be generated in the back half of the year. We still believe that Congress will retroactively delay implementation of the new Tax Research Cost Capitalization Rules, given the number of members from both parties who Co signed legislation to restore pro innovation tax policy before the end of the year. However, if we were to amortize research Costs and pay the taxes currently required, our operating cash flow target would be lower by approximately $150,000,000 With that, I'll turn the call over to Rob, so we can take some questions.

Operator

Thank you. Thank you. Our first question will be coming from the line of Peter Arment with Baird. Please proceed with your question.

Speaker 4

Good morning, Roger, Chris.

Speaker 2

Yes.

Speaker 4

Hey, good morning, Peter. Hey, Roger, maybe you could talk a little bit about how you're seeing The fiscal 2022 enacted came in and certainly the outlook for 2023 looks Even better for when we're talking about the longer term budgets.

Operator

Just kind

Speaker 4

of in the context of how you think Leidos is faring there. And when I think about just also the Dynetics business, and You talked a lot about the program of records, the outlook there. If you could give any kind of insight and is there any potential benefit from activity in Ukraine? I know you do have some

Speaker 3

Hey, Peter, you broke up in the last sentence or 2.

Speaker 4

Just regarding Ukraine.

Speaker 3

Yes. Okay. Great.

Speaker 4

Is there any opportunity there when you I know you have some area defense

Speaker 3

Yes. Well, let me talk in general. So first of all, on Ukraine, Yes, we're probably seeing higher optempo in our defense sector because of Support that the U. S. Is giving to the effort in the supplemental spending.

Speaker 3

But that being said, the conflict, I think long term is probably bad for the industry. We're not in the business of Providing a deterrent. And so I think it's we will spend money now, but we will take it away from the future. And I think it's also kind of bad for the country. It's certainly bad, I think, for Europe, and I think it's really bad for the global community.

Speaker 3

We're seeing more stratification of nations and going back to a tripolar world, and I'm not sure that's really good for anyone. That being said, we probably worked more overtime, which meant Our cost probably went down because we've got more direct labor, that we didn't plan for. And yes, there are some programs that appear to be accelerated because of some of the emerging threats That were used in Ukraine, hypersonics comes to mind, but we have the indirect fires program, which we expect to be fully supported. And then to the extent that anybody is in the weapons business, and we don't have a significant weapons Business, but some of our peers, they make stingers and switch blades and javelins and things like that. And those Inventories and that stock will have to be replenished.

Speaker 3

I think the broader view is Every time I think we as a country get comfortable that we can lower the defense budget because, If you will, pieces broken out across the world. We learned that the world is still a very complicated place and we end up Having to put the money back in the defense budget. So I think the long term prospect is that we will see a strong defense budget for the foreseeable future. And what's especially good for us at Leidos is as the defense budget has moved up, there now seems to be Almost like an iron bar between the defense side and the civil side. So we rarely now are seeing increase on the defense side without A commensurate increase in the civil side, which really provides us a benefit across all of our segments.

Speaker 3

And so now I will As a citizen, as a taxpayer, I worry about the national debt and I worry about balancing the budget someday and all of that. But from My position as CEO, this has all been a real positive for the company and for Leidos. And the strategy that we implemented, which was to be able to address the broad markets within the federal government and some of the international governments. As I said in my comments, we'll see the money start to come through the PBBS system in the second half of twenty twenty two. And then 'twenty three looks like it's going to be another strong year on both sides.

Speaker 3

And frankly, 'twenty four will follow. I just think we're at A place relative to government spending that's going to favor our industry. So thanks for your question, Peter.

Operator

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

Speaker 5

Good morning, Roger, Chris. Thank you.

Speaker 3

Good morning, Sheila.

Speaker 2

Good morning.

Speaker 5

Good quarter. Chris, you mentioned in your comments R and D investment and program execution investment, If need be, was this regard to a specific program with DES or is it broader? And just in regards to profitability for the year, Are you seeing costs come back? Or how do we see the cadence of profitability? Does it step up from Q1 levels?

Speaker 2

Right. Thanks, Sheila. So it's more than a singular program. In fact, it's just been a variety of opportunities. And we encourage our teams, to Be creative and bring forward business cases where they see opportunities that could lead to longer term payoffs.

Speaker 2

And we've seen a number of those opportunities, some on programs that we're performing on That we're all in to make sure we deliver on time and on schedule, and on budget. And so we believe Those performance on those programs will lead to future opportunities with those customer sets. So that's one example, but there's also Areas where we see next generation of certain technologies that we want to continue to invest in because we believe the demand will be there. As it relates to the pattern of profitability through the year, we always had an expectation that, that would build as we progress through the year for a variety of factors, Some of which just the timing that we have visibility into program performance, product deliveries are a little bit more back end loaded over the course of the year. Programs like Navy Next Gen, which has been ramping up very nicely, there's more project work now that we're into that program, 6 Plus months and the team sees opportunities as we move to the back half of the year to continue to deliver for the Navy customer.

Speaker 2

So again, I think the pattern With some modest increases over the course of the year, and that will counterbalance some of the things that we're seeing in Health where the margins were a little Inflated in the Q1, as you saw. But as far as the close on your indirect spending question, it's not a surprise to us. We certainly anticipated Getting back, being on the road, being involved with trade shows as necessary. And so as we built our pricing rates for the year,

Operator

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

Speaker 6

Yes. Thanks so much. So like, khaki, you guys had a weak funding to sales in the quarter per se, 0.9, Although your trailing 12 of 1.01 is stronger, can you give us some color on the cadence Throughout the quarter in terms of funding and whether it's picked up here in April and there following on to that maybe some Help in terms of the cadence of revenues and earnings over the next three quarters?

Speaker 2

Sure, Cai. So, it varies on the funding. And Right now, I would tell you other than one particular example that comes to mind where we wish there was a little bit more immediate funding on a particular program With one of our customers, funding hasn't been an issue in some of the awards that we won, most notably on the VBA contracts, that funding will be there over It's just the way it gets recorded. So we don't see funding as an issue. And in fact, we're starting to see some customers come to us and say, I'm anticipating more funding being available on these particular programs.

Speaker 2

What types of things could we potentially do? So That's the way we're seeing things play out. And I'm sorry, the second part of your question was on the progression of revenue and earnings?

Speaker 6

Yes, the progression of revenue and earnings over the year.

Speaker 2

Right. So it's a modest uptick as we see the year playing out. Obviously, we just got started. Roger talked about our Aegis So there was really no contribution of that in the Q1. That will start to contribute more in the second and build through the second half For the year, there's obviously some other new start programs that we just talked about.

Speaker 2

One of the key variables will be within health and how we see the exam volume moderating, but we've We anticipated that coming back down to the more normative levels that we've discussed. So think about steady uptick in the run rate With the growth rate, it will moderate. As you know, the back half of last year was a little bit stronger, so you'll see those growth rates dial down. And then I think margin profile We'll continue modest increases over the course of the year.

Speaker 3

Yes. Kai, I would add on the funding side. When we start some of these very, very large programs, getting the billing process where we aggregate bills and Getting the contracting officer, that whole process to work as smoothly as it will on a mature program takes us a couple of cycles. And so it's not the available funding at the customer level. It's getting the process of Submitting invoices, aggregating invoices, working with contracting officers, some of which are new to us because these are new programs and just Getting that process to operate as efficiently as we do on our more mature programs.

Speaker 3

So we expect as the year goes on that you'll see that reverse. Thank you. Thank you.

Operator

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

Speaker 7

Hi, good morning.

Speaker 1

Good morning.

Operator

Hey, Rob.

Speaker 7

Roger, I wanted to ask on the SDA business, where that's running and if that's improving with the traffic recovery. I think it was may it may be trending at about, I don't know, 60% of where you where it was when you acquired it?

Speaker 3

Let's see. There is more proposal activity, and we're out on the road We're engaged with customers more. But like any acquisition process, when you essentially come to a stop, Getting it started again, so there's a RFI, there's an RFP cycle, and it just takes time. And air Traffic in the U. S.

Speaker 3

Is at or better than. International is still lagging, and then in certain regions, They're still lagging, but our team is traveling again. In fact, the Group President has been overseas Talking to airports, and the airports are now coming forward with new forward plans post COVID, which will include modernization of both Checkpoint and baggage. And we've been investing in technology. We're trying to get to a touchless Passenger experience, which I think is kind of the Holy Grail of all of us who want to go through airports, But that's just going to take time.

Speaker 3

So the recovery has been slow and it's going to take us well into 2023 before we get back.

Speaker 7

Okay. And can you remind us what the domestic versus international split

Speaker 8

is in that business? And then, Chris, I have

Speaker 3

a quick one for you.

Speaker 2

Yes. I mean, Rob, I don't know that we've given a precise estimate of that because it ebbs and flows, right, where the demand signal comes from in the service. But So these days, it's less internationally focused, a little bit more domestically focused. But to Roger's point, where we see that Bounce back in that future demand will be more internationally focused when that does occur.

Speaker 7

I probably should have asked it as installed base. Maybe that's a better way to think about it? No.

Speaker 2

Oh, gosh. We're going to test this now. More installed base internationally.

Speaker 7

Okay. And then Chris, just on backlog, how much of that is fixed price? And to what extent do those contracts have Annual escalators like CPI or ECI to protect a bit? Well,

Speaker 2

The large awards in Health this quarter are like a fixed unit rate pricing. And by and I would tell you, while we don't have Necessarily escalator protection, we spent a lot of time in our pricing building The forward rates and oftentimes those are prescriptive assumptions by the customer and if things deviate, you have an opportunity to revisit that. But We take that estimate of inflationary cost increases into consideration when we're building up our price point. As far as the overall, our fixed price concentration hasn't moved much As a percent of revenue, so you're kind of seeing the new orders come in along the same lines of what we've seen historically.

Speaker 7

Okay. So no real change to your long term margin expectations from inflation?

Speaker 2

No, not at this time. We're Doing the best we can to combat that as we price new opportunities and having still more than 50% cost plus Mix of the portfolio certainly gives you some backstop insulation, but we're certainly being thoughtful about pricing the fixed price components of the new bids.

Speaker 7

Sure. Thank you.

Operator

Our next question is coming from the line of Gavin Parsons with Goldman Sachs.

Speaker 9

Maybe just a follow on the inflation question. Roger, a couple of quarters ago, you made the point that if the customer doesn't necessarily or the customer will lose purchasing power if they don't It seems like now we have a placeholder for inflation in the DoD fiscal 2023 budget. So is it your sense That the government customer is cognizant of the inflation environment, both in terms of real purchasing power and cost inputs?

Speaker 3

Well, let's see. It's hard for me to judge whether the government customer writ large Understands the complete impact of inflation versus a real growth in their budget. Certainly, A variety of customers that we talk to. And I would point out, Gavin, the fuel cost is an immediate problem For, say, the Department of Defense, especially as they have increased optempo and they have to buy the fuel. It comes out of the working And so there are a variety of things that are happening in the macro Economy that are going to cap down sort of the enthusiasm on the top line increase.

Speaker 3

And let's see, my view is that at the SecDef, DepSecDef level, they completely understand that. I don't think they're going to get supplemental for inflation. I think that they're Thinking through the impact to the overall budget as they look at 'twenty three and 'twenty four. But I also I'll just share with you what the rhetoric is around town here in Washington is that We will not sustain inflation at this rate. As we come out of the back of the pandemic, As we get to whatever normal is in Ukraine, inflation will come down, maybe not Pre COVID levels, but won't sustain at this level.

Speaker 3

And I know there's a lot of focus on quarter by quarter these numbers, but The economic the economists that I talk to and the reports that I am reading are that this will Temper over the next quarter or 2 back to a more normal level, which will give them a little bit more real top line.

Speaker 9

Okay. Appreciate that insight. And then maybe just in terms of reiterating guidance, it seems like you've Derisked a lot of the risk factors that were originally in place when you guided. Could you talk a little bit about kind of what the moving pieces are that would take you towards the higher or low end of the range

Speaker 3

Yes. I'll start and then Chris can add. What we said is we're still within the range that we have Put out in the marketplace, although there are obviously pluses and minuses, and I made a comment in my prepared remarks That a lot of risk has been retired and we have more confidence in our ability to meet our numbers for the year. But it's the Q1. There's a lot of uncertainty.

Speaker 3

I don't know what's going to happen in Ukraine. And you should take away is We're still bounded by our guidance, but the team here is certainly a lot more confident Than we were when we talked to you at Q1 when we didn't have a budget. We didn't know about defense enclave services. We hadn't gotten out of the Aegis protest. So there's a lot Good things going on from a forecast standpoint within Leidos, but we're still clearly within Our upper and lower bounds in our guidance range.

Speaker 2

Yes. Gavin, that's certainly the thought process that we went through, right? And we're A lot we've learned from last year, things could evolve. The speed at which we think the positive budget environment flows through to orders, we'll have to Watch that carefully over here over the next couple of months. There's some exciting new programs that we're we've been bidding on.

Speaker 2

And so depending upon those decision timings over the next 2 to 3 months could certainly be positive catalysts for us. But at this point in time, we're on a nice trajectory. We're still in, we believe, the overall ranges The The

Operator

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

Speaker 8

Hey, thanks very much. Good morning.

Speaker 2

Good morning, Seth.

Speaker 3

Good morning, Seth.

Speaker 8

So I just wanted to start off with Health And the profitability there and I know that that kind of nearly 20% is not necessarily a normalized margin, but It's better than what was a very high margin last year. I guess, How should we think about what's going to cause that to decline? Saw there was a win on the medical exam contract in the quarter. So you probably have a little bit more visibility there. Were medical exams down year on year and the margin rate Still went up?

Speaker 8

And if so, kind of what drove that? And do those drivers give you an ability to maybe sustain something that's closer to high teens?

Speaker 2

Yes. Seth, let me start and Roger can pile on. So for the Q1, we're not Featuring the Exam business as the primary driver for strong margins, I mean, I have to give it to the DHMSM team. They're just doing an excellent job. And we saw, Again, as they've deployed more, they're seeing more efficiencies.

Speaker 2

And we talked about procurement and delivery in our prepared remarks, How we're delivering software for the customer, finding opportunities to get more efficient in doing so. So that one really helped contribute in the quarter. That was a little bit of A one time pickup, but actually it will help us on an ongoing basis maintain a little bit higher margin profile there. The Exam business is doing well. I mean, I would say Largely about the same levels of where we were a year ago.

Speaker 2

And I think if you read carefully our prepared remarks, We talked about 2 things. Number 1, we're excited to have won a position internationally, which provides opportunity to expand that business in an area we haven't been before. On the flip side, on one of our regions, one of the areas we perform on, we were re awarded that contract, but they also Added a couple additional suppliers potentially to the mix. So we don't know how that dynamic will play out as far as how the caseload gets So that's certainly an area that we'll have to watch and moderate and could potentially we're anticipating we'll put some downward pressure on margins over the course of the year, but

Speaker 3

Yes. Seth, I'll just add a little bit of color. So the number of exams that we do per day per week Maintaining strong through the period. The discussion that we've had with the customer is, there is a potential this year and next year that They will go back and review what they call prior presumptive cases, things related to agent orange and some other things that might Sustain the volume in the Exam business sort of above what we have forecasted. We've had those discussions with the customers.

Speaker 3

We haven't Seeing the volume come all the way through yet, so it's a bit of wait and see. And on the District 6, which is your transition exam when you leave the active military and you go to VA, they added, And you go to VA. They added another actually added 2 more contractors because of that there will be added volume through these presumptive cases. And we can talk more about it as the quarters go by. But It's really, really important for our customer to provide a timely medical exam to the people who serve the country, So they want to add more capacity into the system because they think they'll have more exams, and we'll just have to wait and see how it plays out.

Speaker 8

Okay, great. Thanks. And then just as a quick follow-up, it seems like the company is in a pretty strong place with regard to The revenue outlook for the year with regard to the margin guidance, it seems that margin rate should Expand through the year, but health is probably at an unsustainable level in Q1 and you've talked about some more investments. And so what's kind of the driver of an improving margin rate?

Speaker 2

Yes. There's a variety of things, Seth. I mean, well, First of all, on the investment questions, if we see smart investments, we believe for the long term, we're going to fund those even if they were over and above the But as of right now, obviously, we are holding to our guidance. I talked about some of the product deliveries, although As Roger alluded to, the SDA business is not where we ultimately hope it will be. We're still shipping some products and those are more back end loaded over the course of the year.

Speaker 2

We'll be ramping up some new program wins. That scale will continue to increase. The NGEN project work is back end loaded. And some of the projects Dynetics working on and delivering, we're anticipating better performance over the back half of the year. So there's a variety of factors across the portfolio.

Speaker 2

We're not Far off, obviously, at 10% 2% margin. We're not far off of what our goals are, but you're right, we're preparing for health moderating down and The other parts of the portfolio moderating up a little bit this year.

Speaker 8

Perfect. Thanks very much.

Speaker 3

Thank you.

Operator

Our next question is coming from the line of Bert Soudin with Stifel. Please proceed with your question.

Speaker 10

Hey, good morning.

Speaker 2

Hey, good morning. Hey, Bert.

Speaker 10

So following up on the SD and A question, Roger, you said last quarter normalization was something in the ballpark of several $100,000,000 higher. So you could see up to or greater than a 2 point organic tailwind for that business heading into 2023, could you not?

Speaker 3

Without doing the math in my head, we're

Speaker 2

currently in. Well, yes, but I mean, it can all bounce back overnight, right? We're not expecting that we'll get A step function increase, but that's where we think we'll ultimately be able to get back to.

Speaker 10

Okay. And then just a quick follow-up. Can you just give us an On where things stand with the hypersonics business?

Speaker 3

Sure. We make the Common hypersonic glide body down at Dynetics in Huntsville, and we have delivered our first Leidos manufactured common hypersonic glide body to the customer and we are ramping up production. I can't Sure what the production numbers are, but it's a fairly steep ramp. The program is fully funded. We also won, we've talked about this in the past, the thermal protection system contract.

Speaker 3

This is the coating that goes on the outside Of the common hypersonic glide body and so we're producing and manufacturing the thermal protection system. And I will say this, we have ample capacity to raise our rate significantly above what we're contracted for. And then we also make the launcher, which is more associated with the parent program, the long range hypersonic weapon. And we had delivered our first tranche of launchers in there with the Army doing training. And we're in a position to build additional launchers as those contracts get written.

Speaker 3

But We're excited about the program. We believe there's a huge near term need. And although we're conservative in what we put in our financial forecast, We clearly think there's upside on the hypersonic business.

Speaker 2

Yes, Bert, we're really excited about the team is doing a great job. In fact, Roger and myself, few other executives

Speaker 10

Thanks, Roger. Thanks, Chris.

Speaker 5

Yes.

Operator

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

Speaker 2

Hi, good morning. Thanks for the question, guys. Hey, good morning. I wanted to ask about good morning. I just wanted to ask about DES.

Speaker 2

And realizing that

Speaker 8

that program is still under protest, but assuming that does come back to you at some point later this year, how should we think about Kind of the pacing of how fast that could ramp up and ultimately what sort of the run rate we should expect on that program?

Speaker 3

Yes. Well, I'll give you an overview and then Chris can sharpen the numbers part of it. We're in protest. We're Optimistic that the GAO will rule on time. It clearly could go to another round of protests, it could go to court of federal claims, But it is a very slow ramp.

Speaker 3

So let me describe the program as this is DISA taking over more IT environments to come to, if you will, a common network approach across DoD. And so we will transform networks of other DoD agencies outside of the services, and this happens kind of an agency by agency basis. So the first couple agencies that we will transform are relatively small. So if We come out of protest in June. The revenue this year is very small, almost double digit, But not much more than that.

Speaker 3

And then it builds over time. I would caution Dividing $11,500,000,000 by $10,000,000,000 in your model, we have to win and achieve that. I mean, there is a potential to do that several years out, but it's not at that level in our models. It's smaller than that. That's an IDIQ ceiling, if you're familiar with how that contract works, that gives the customer room to grow and to spend at that level.

Speaker 3

But from our own internal modeling, it will be a slow ramp and will actually take years to become a significant program at that level.

Speaker 2

Yes. I mean, Matt, I'm probably going to dodge your question even more. Obviously, we don't want to get ahead of ourselves. Very excited To get the win notification, have a high degree of confidence in our team. They know how to defend protests.

Speaker 2

And We're going to go through that process. We're going to see what happens in June. And to Roger's point, I feel like this is a program that will continue to drive growth For multiple years, that's the good news. And we'll do everything we can to deliver for the customer, maximize the value of the contract Because that means we're really delivering great capability to up to 22 agencies within the DoD for the state. But think about this potentially, It will become, we believe, one of our top programs, but don't expect that in 'twenty three and probably not in 'twenty four.

Speaker 2

It will take multiple years to get there. Got it. Thanks. That's helpful. And then if

Speaker 8

I could just do one more on kind of the hiring environment. You guys have won a lot of new work here. What are you seeing? Is it getting any easier to hire people? And are you kind of confident you can get enough people to support all this new work?

Speaker 3

Yes. It's really interesting. We're a people company and literally every day, almost every hour, we're talking about people and hiring. And the great resignation means people are moving. And if they're resigning from Leidos, they're going to work someplace else.

Speaker 3

If they're resigning from someplace else, they're coming to work at Leidos. And so our accepts are in the 90% of the offers that we make. We fill most of our positions between 30 45 days. So it's not a hiring problem. It's a retention problem.

Speaker 3

And we all have I've got kids and Coming out of COVID, people are looking around. They want to try something different. And so we're doing a lot. If you were in our meetings, we have a great Talent acquisition team, they're doing a great job and we can always do better. But we're spending a lot of our time On how do we continue to make Leidos an attractive place, not to come to work, but to stay.

Speaker 3

And so this is career development. This is Investing in the future of our employees. This is what we call upskilling, just some new languages like Python and things like that, So that they can have a new job and stay at Leidos, if you will. And there's a lot of work. And I know I was Talking to some of our competitors and they have the same problem and we're all focusing on employee development, not much from a hiring standpoint.

Speaker 3

By the way, there's always a shortage of cleared computer science majors with Access in the Intel world, that's always going to be a challenge. But you should not You listened about the great resignations and say, oh, they can't hire the people. We've been very, very successful in attracting and hiring, and now our emphasis is on retention.

Speaker 2

That's helpful. Thanks.

Speaker 1

Yes.

Operator

Thank you. The next question is from the line of Colin Canfield with Barclays.

Speaker 11

Hey, good morning. Could we just level set the growth narrative here? Unchanged guidance Suggest that you need to hit roughly 7% organic in FY 2023, 2024. So then as we look out over a multiyear period, What are some of the pain points that you guys are looking at split between headcount issues, supply chain, really kind of what does it take to not achieve those levels?

Speaker 2

Well, Collin, I mean, over a multiyear time horizon, right, things can go wrong. And we've been talking about some of them here that Roger just feature Retention, right? So it's not a hiring issue per se. It's certainly making sure we can retain people to have the headcount we need to achieve that level of growth. First of all, yes, we put that multiyear guidance out in October.

Speaker 2

We knew when we put this year's guidance out, we were on the lower end of the range. Off to a good start. We're not updating this year's guidance at this point in time, but we just talked about things like DES and catalyst for future momentum. So then it becomes, can you execute? Can you Can you get the people on the supply chain?

Speaker 2

So we're watching all those things very carefully. I mean, all indicators at this point in time are nothing would take us Away from feeling like we can still achieve those longer term objectives. So that's the trajectory we're on, but clearly something we focus on All the time as we go through and execute and deliver for our customers every day.

Speaker 3

And Collyn, there's still some big Opportunities we have to win, we've talked about the FANS program, which has now been delayed to the fall. And there are A series of multibillion dollar programs that are still in our pipeline. And so we have to continue to do what we're doing, hire the people, Execute in the business development area, win the programs and then staff the programs. And then the customer has to fully fund. And right now, I think 2022 and 2023 look pretty solid.

Speaker 3

But if there is a big sea chain, frankly, if We get into a war where the U. S. Is actually involved that will reprioritize spending within the federal government, maybe away from long term to actual combine operations. We're hopeful that won't happen, but that could have a significant effect on how we view the future.

Speaker 11

Got it. And then in terms of CapEx for the year, can you just discuss some of your biggest investment areas and the return metrics that you're contemplating within that portfolio?

Speaker 2

Yes. So when we put together our CapEx plan for the year, all of our business have a variety of needs and there's a laundry list of items. Some of the bigger ones We're in the airborne ISR business, and that's an area we've made some investments and generated excellent returns with IRRs certainly Mid to high teens, if not better. So we certainly look at the risk of an investment. We look at our weighted average cost of capital.

Speaker 2

We try to generate Returns obviously that exceed that. And we're still putting money into as much as we're trying to overall shrink and densify our facility footprint, There are certain areas, especially in the Intel space, new classified facilities we're having to invest in and some areas on the manufacturing side that we're investing in. So side that we're investing in. So Facilities will probably be our 2nd biggest expense area. And then it's just a variety of smaller initiatives across the company.

Speaker 1

Rob, it looks like we have time for just one more question.

Operator

Yes. That question is coming from the line of Mariana Perez Mora with Bank of America.

Speaker 5

Good morning, gentlemen.

Speaker 2

Good morning. Good morning.

Speaker 5

My question is a follow-up to Kai's question. As we try to understand the market trends versus the company specific story, would you mind giving us some color on How much of the 4% organic growth or how much of like the low single digits organic growth embedded or implied in your guidance is related to Legacy programs, how much is related to new and ramping up contracts and how much is related to loss recompete?

Speaker 2

So you're talking about, Mariana, our organic growth profile and kind of dissecting that a little bit is what I think I heard from that question. We're certainly seeing some uplift and we look for what we call on contract growth every year as we build our plan between inflationary pressures on cost To existing customers, that's certainly an area that's contributing a couple points of growth at a minimum. We look for that. And then obviously comes down to the NuStar programs. We've talked featured many of those.

Speaker 2

NGEN will still be a growth story for us this year. Military Family Life Counseling continues to ramp up. We talked about Aegis. So some of those new mega programs are probably The next thing I would point to, to give us confidence on this year's growth trajectory. And then Roger just talked about the pipeline is still rich and we're continuing to pursue Multiple programs beyond that to fuel our growth.

Speaker 2

So I'm not sure if that exactly hit on your question, but happy to expand as necessary.

Speaker 5

No, that's good color. And then I'll switch gears to M and A. Can you mind giving us some color on what's in the pipeline in terms of how large it is And what kind of like companies, customers, capabilities are you looking for on those tuck in or bolt on acquisitions?

Speaker 2

Well, Marianne, I mean, we won't give you too much in the way of specifics as far as what we're looking at in the M and A arena. But I would tell you that A lot of properties continue to come to market. Roger talked last quarter about and followed up again this quarter, the mega properties, the larger ones are That's interesting to follow. But we look at things that make sense to us. We vet things and but we're going to be thoughtful about where we engage.

Speaker 2

And Back to his prepared remarks, it really has to fit a strategy niche for us.

Speaker 3

So Yes, Marianne, I would just foot stomp. We're really happy with our portfolio today. And so we look at

Speaker 2

M and

Speaker 3

A is a way to accelerate technology or customer access or relationship with a customer. We were fortunate to be able to do some larger transactions early, and It rounded out our portfolio. And now as we see technology advance, there's always a couple of areas Where I think our time to market would be benefited by partnering with a company rather than trying to develop that internally. And then there are still customers in the federal space that we don't have a long term relationship with. And so if we're able To accelerate that relationship through another company that has A great portfolio will do that.

Speaker 3

Otherwise, as we said in our capital allocation, we're really thinking about how do we get Value back to you, our shareholders. So thanks for the question.

Operator

Thank you. At this time, I'll the floor back over to Stuart Davis for closing remarks.

Speaker 1

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

This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
Leidos Q1 2022
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