Leidos Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
February 14, 2023

There are 10 speakers on the call.

Operator

Welcome to Leidos 4th Quarter 2022 Earnings Call. At this time, all participants will be in listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded. At this time, I'll turn the conference over to Stuart Davis with Investor Relations.

Operator

Mr. Davis, you may now begin.

Speaker 1

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our Q4 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're using today. 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 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, we'll discuss GAAP and non GAAP financial measures. With that, let me turn the call over to Roger Krone, who will begin on Slide 4.

Speaker 2

Thank you, Stuart, And thank you all for joining us this morning. Oh, and by the way, Happy Valentine's Day. The 4th quarter marked a strong finish to banner year for Leidos with record revenue and non GAAP diluted EPS driving us to the top end of our revenue guidance range and beyond our EPS guidance range for the year. Our performance validated that our diversified and resilient portfolio And our investments in technology and innovation are positioning us for growth in key customer missions, including digital modernization, cyber, hypersonics and force protection. Each and every day, our 45,000 people are helping our customers execute on important missions and meet the world's most complex challenges.

Speaker 2

Against a challenging backdrop in 2022, we delivered on our financial commitments, allocated capital to deliver value for our shareholders, Won multiple franchise programs that position us for future growth and significantly grew our talent base. So let me provide more detail on each of these points. Number 1, our strong financial performance in the 4th quarter enabled us We're up 6% and 5%, respectively. Adjusted EBITDA margin of 10.7% And the quarter was up 40 basis points year over year, which helped drive adjusted non GAAP diluted EPS To a record $1.83 which represents growth of 17%. For the year, adjusted EBITDA margin of 10.4% helped lead to non GAAP diluted EPS of $6.60 which was well above our guidance.

Speaker 2

We generated $105,000,000 of cash flow from operations in the quarter And free cash flow of $52,000,000 For the year, that translates to nearly $1,000,000,000 of cash flow from operations and $857,000,000 in free cash flow, which were right at guided levels. These results came despite multiple headwinds, most notably a protracted continuing resolution to start the year, Inflation, supply chain disruptions and labor constraints. Even at industry leading scale, We're nimble enough to pivot as needed, and I'm proud of how well the team pulled together and weathered these challenges. Number 2, in 2022, we allocated capital to deliver value for our shareholders. Over the year, capital deployment was heavily weighted towards return to shareholders, while still layering in Strategic acquisition of the Australian Airborne Business and investing to grow our core business through capital expenditures And internal R and D.

Speaker 2

With our asset light model, CapEx was just under 1% of revenues With large investments in airborne ISR and Dynetics, and we're seeing those investments pay off in additional aircraft Performing valuable missions and key wins in hypersonics, which takes me to number 3, business development. This year, we won franchise programs in each segment that position us for growth, programs like DES in defense, Social Security Administration IT in Health and AAGES in Civil contributed to performance in 2022 and have built the foundation for 2023 and beyond. They demonstrate our ability to take away work and target brand new opportunities. In the 4th quarter, which is typically the weakest in our industry, We booked $3,700,000,000 of net awards for a book to bill ratio of 1.0. For the year, Our book to bill ratio was 1.1.

Speaker 2

Total backlog at the end of the quarter stood at $35,800,000,000 of which a record $8,400,000,000 was funded. Total backlog is up 4% And funded backlog is up 13% year over year. After a relatively slow start to the year across the 3, contract activity is improving. Most importantly, our submit volume picked up dramatically in the 4th quarter with $23,000,000,000 in submits, of which 92% was for new business. Taken together, the 2 Social Security Administration IT task orders that we spoke of last call We're the largest award in the quarter.

Speaker 2

GAO dismissed the competitors' protest earlier than expected, And that program has fully ramped. We also won more than $500,000,000 in hypersonics award, including Mayhem, Our first major contract on the air breathing side and wide field of view tranche 1, which is the backbone of the nation's Hypersonic's defense capability. We're pleased that so many of you were able to join us in Huntsville last December To get a clear picture of the opportunities that we see at Dynetics, our independent research and development investments We're critical to procuring these awards just as they were for our landmark wins in digital modernization. In 2022, we invested $116,000,000 in IR and D and IRAD has grown at a compound annual rate Of 23% over the last 5 years, we continually invest to develop proprietary tools And unique processes to drive competitive advantage. We've already deployed workflow transformations Using the latest generation of AI based on large language models, and we're at the leading edge of combining artificial intelligence And cyber to enable our customers to achieve security levels that are beyond compliance.

Speaker 2

Speaking of cyber, earlier this month, we announced the latest version of our 0 Trust Readiness Level tool suite That simplifies 0 Trust adoption for government organizations, consolidating a 6 to 9 month planning process To less than 60 days, we drive digital innovations by working tightly with our product partners. For example, we've partnered with Intel Corp to demonstrate confidential computing through a hardware based, independently attested, Trusted execution environment. And just last month, we were recognized as the 2023 ServiceNow, America's Premier Partner of the Year. Number 4, We significantly grew our talent base. We hired more than 2,400 people in the 4th quarter And more than 11,000 in 2022.

Speaker 2

Hedge count was up 6% for the year and attrition rates Continue to subside. We've seen great synergy between our people engagement and technology investment initiatives. Employees in our technical upskilling programs have significantly higher retention, and we more than doubled participation In 2022 compared to 2021, our technical upscaling programs are aligned with our technology strategy and Broad participation is enabling us to enhance our competitive position and deepen our culture of innovation. If you want to build your technical skills over a fulfilling career, Leidos is a great place to work. In 2022, we offered courses in artificial intelligence and machine learning, software, cyber, Cloud and Digital Engineering.

Speaker 2

In 2023, we're expanding with new offerings in cyber operations, Secure rapid software development and specialized learning pass in AIML. We also take learning and engagement beyond the Classroom, 2 weeks from now, we'll launch our 7th annual AI Palooza Challenge, where employees around the company will engage With some of the newest AIML techniques in a creative and collaborative competition, perpetual learning is part of our culture, And we make it fun. Before turning it over to Chris, I'll touch on the current budget environment. Demand trends are very positive for our business. Late last year, Congress overwhelmingly passed and the President signed The Omnibus Appropriations Bill funding the government through September.

Speaker 2

Budgets across the board saw healthy increases, Including defense spending, which was up about 10%. The budget addressed the critical challenges we're facing as a nation, including national security concerns arising from China and Russia, and Leidos is well positioned to respond. Amidst a highly partisan backdrop, President Biden's calls in the State of Union address to support Ukraine, Protect our country and modernize our military to safeguard stability and deter aggression received strong bipartisan That said, we're anticipating a series of noisy debates over the coming months Around the debt ceiling and the 2024 Appropriations, given the razor thin majorities and the deep divisions in Congress. As a matter of prudence, we're preparing contingency plans around a potential government shutdown, But we built our 2023 guidance assuming a continuing resolution beginning in October And extending through the rest of the year with no government shutdown. We believe this is the most likely outcome.

Speaker 2

In summary, I'm pleased with the performance and the momentum of the company. In the 4th quarter, We posted record levels of revenue, non GAAP diluted EPS and funded backlog as well as the highest adjusted EBITDA And adjusted EBITDA margin and lowest attrition rate for the year. We anticipate that 2023 Will be another good year for Leidos, marked by strong hiring, important new wins, solid growth in revenue and operating income. With that, I'll turn the call over to Chris for more details on our results and our 2023 outlook. Thanks, Roger, and thanks to everyone for joining us today.

Speaker 2

Let me echo Roger and express my gratitude to the entire Leidos team for how we We navigated many challenges throughout the year, including an unexpected adverse arbitration ruling in Q2 To deliver at the top end of our revenue guidance range and above our EPS guidance range for the year, all while delivering for our customers. Turning to Slide 5. Revenues for the quarter were $3,700,000,000 up 6% compared to the prior year quarter. For the year, revenues were $14,400,000,000 which was up 5% compared to 2021, despite $107,000,000 headwind from foreign Currency movements, primarily from work in the U. K.

Speaker 2

And Australia in our Defense Solutions segment. 2022 revenue Performance was in line with the targets that we laid out 16 months ago for 'twenty two through 'twenty four. Turning to earnings, adjusted EBITDA was $397,000,000 for the 4th quarter for an adjusted EBITDA margin of 10.7%, Our highest margin of the year and above expectations based on higher growth on more profitable programs, better performance on some large programs In disciplined cost management, 2022 adjusted EBITDA was $1,490,000,000 for a margin of 10.4% We're right at the midpoint of guidance that we've held all year. Non GAAP net income was $255,000,000 for the quarter And $919,000,000 for the year, which generated non GAAP diluted EPS of $1.83 for the quarter and $6.60 for the year. Non GAAP diluted EPS was up 17% for the quarter and essentially flat for the year as a result of some one time events that we've talked about in the past.

Speaker 2

Looking at the key drivers below EBITDA, The non GAAP effective tax rate for the quarter came in at 20.1%, which was below our expectation and added about $0.09 to EPS. The tax rate benefited from certain international tax credits and limitations, increases in our federal research tax credit and higher than planned stock compensation deductions. In addition, net interest expense in the quarter increased to 51,000,000 from $46,000,000 in the Q4 of 2021. Finally, the weighted average diluted share count for the quarter was 138,000,000 Compared to $142,000,000 in the prior year quarter, primarily as a result of the $500,000,000 accelerated share Purchase agreement implemented in the Q1 of fiscal year 2022. Now for an overview of our segment results and key drivers on Slide 6.

Speaker 2

Defense Solutions revenues in Q4 of $2,070,000,000 were essentially flat compared to the prior year quarter. 2022 Defense Solutions revenues of $8,240,000,000 were up 3% for the year. Civil revenues We're $938,000,000 in the quarter, up 17% compared to the prior year quarter, and 2022 revenues were $3,460,000,000 Up 10% compared to 2021. The primary driver for growth in the quarter the year was the ramp on the NASA Aegis program. In addition, we had good growth within our commercial energy business as well as increased security products, sales and maintenance.

Speaker 2

Health revenues were $691,000,000 for the quarter, an increase of 10% compared to the prior year quarter, driven primarily by performance on DHMSM and our new work on SSAIT. Health revenues were $2,690,000,000 for the year, up 5% over 2021 with the same drivers that I cited for the quarter plus Strong performance on the Military and Family Life Counseling Program. On the margin front, on Slide 7, Defense Solutions and Civil posted their highest margins in more than a year based on mix and some excellent program performance. For the quarter, Defense Solutions non GAAP operating margin came in at 8.6%, up 40 basis points compared to the prior year quarter And Civil came in at 11.2%, up from 10% in the prior year quarter. Defense Solutions non GAAP operating margin for the year was 8.3%, which was down 30 basis points from 2021, Primarily from investments in new program start ups, civil non GAAP operating margin for the year was 9.2%, Down from 10.2% in the prior year, driven by legal matters that we've addressed in prior calls, a $26,000,000 gain in 2021 And a $19,000,000 expense in 2022.

Speaker 2

Health non GAAP operating margin for the quarter was 14.3%, consistent with what we've been talking about for some time. Health non GAAP operating margin for the year finished at 17.1%. Turning now to cash flow and the balance sheet on Slide 8. Operating cash flow for the quarter was $105,000,000 And free cash flow, which is net of capital expenditures, was $52,000,000 For the year, operating cash flow was just shy of $1,000,000,000 And free cash flow was $857,000,000 for a 94% conversion rate. In the 4th quarter, we completed the acquisition of the Australian Airborne Business, which provides maritime surveillance operations for the Australian Border Force and search and rescue response capability The Australian Maritime Safety Authority, purchase consideration was approximately US190 $1,000,000 net of US6 $1,000,000 of cash acquired.

Speaker 2

During the fiscal year 2022, Leidos returned $741,000,000 to shareholders, including $199,000,000 is part of its regular quarterly cash dividend program and $542,000,000 in share repurchases. As of December 30, 2022, the company had $516,000,000 in cash and cash equivalents and $4,900,000,000 in debt. Roughly $1,000,000,000 of that debt will come due in this year, most of it in May. We expect to fully repay the remaining $320,000,000 on the short term loan originally tied to the Gibbs and Cox acquisition and then rolled over in support of the ASR program will refinance $500,000,000 of maturing bonds as well as the bank term loan A still tied to LIBOR in an efficient and flexible manner, but interest expense will increase given the current rate environment. As we approach the debt market, we're pleased with the recent upgrade from Moody's to B AA2 credit rating, which signals their confidence in our financial stability and outlook.

Speaker 2

We're already benefiting from improved terms on our commercial paper borrowing and expect that to carry through on the debt transactions. 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 to the forward outlook on Slide 9. For 2023, we expect revenues between $14,700,000,000 $100,000,000 reflecting growth in the range of 2% to 5% over fiscal year 2022.

Speaker 2

Demand remains strong as our customers execute robust budgets, and we enter 2023 with a number of programs that are ramping, but the procurement process is still protracted. We expect 2023 adjusted EBITDA margin between 10.3% 10.5%. The midpoint of the margin range is the same as 2022 and the top end is consistent with the target that we laid out at our October 2021 Investor We're committed to long term margin expansion, and we'll pull multiple levers to offset the impact of inflation In supply chain, on our cost structure, as we demonstrated in the back half of twenty twenty two. We're closely managing our corporate cost with a special focus on real estate. GAAP net income in the quarter reflected impairment charges of $37,000,000 from Exiting and consolidating underutilized leased spaces.

Speaker 2

Since beginning our journey to optimize our real estate footprint post COVID, We've exited over 2,000,000 square feet, which is about 25% of our office space. Getting out of that space improves our competitiveness And keeps corporate costs in check. We expect non GAAP diluted earnings per share for 2023 between $6.40 and $6.80 on the basis of 138,000,000 shares outstanding, which is unchanged from 4th quarter levels. To provide some context around that range, we expect 2023 net interest expense of approximately 225,000,000 And a non GAAP tax rate between 23% 24%. These two items amount to an EPS headwind of about $0.20 for the year.

Speaker 2

Finally, we expect operating cash flow of at least $700,000,000 This guidance reflects approximately $300,000,000 of additional cash taxes compared to fiscal year 2022, primarily related to the Tax Cuts and Jobs Act 2017 provision requiring the capitalization and amortization of research and development costs. As we're awaiting potential congressional We didn't make any Section 174 related tax payments last year, so we'll need to make payments this year to cover both 202223. We paid the 2022 Section 174 taxes in January, and we expect to pay the 23 taxes in quarterly installments throughout the year. From a free cash flow perspective, we're targeting capital expenditures of approximately 1.5% of revenues Based on the timing of some investments in Australian and U. S.

Speaker 2

Airborne surveillance as well as in sourcing some of the security product supply chain. As is our usual pattern, cash generation will be back end weighted in 2023. Along with the tax and debt payments in Q1 and Q2, This limits the ability to deploy capital for shareholders in the first half of the year. As a result, the EPS guidance range does not account for any repurchases, and we'll update you as we go throughout the year. With that, I'll turn the call over to Rob, so we can take some questions.

Speaker 3

Thank you. At this

Operator

time, we'll be conducting a question and answer session. A confirmation tone will indicate your line is in the question may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Thank you. Thank you.

Operator

And our first question comes from the line of Robert Spingarn with Melius Research. Please proceed with your question.

Speaker 4

Hey, good morning.

Speaker 2

Hey, good morning. Good morning, Rob. Chris, about the guidance, I wanted to ask you if you might not give us some more detail on a segment basis For the what drives the 2% to 5% growth across the segments? And then how do the margins look relative to the 'twenty two performance on a segment basis? Well, Rob, you know that we don't guide by segment, but I'll give you a little additional color commentary.

Speaker 2

First of all, we're planning on growth across all of our segments. And our leaders have signed up to that. We feel good about that. We're seeing strong demand in pipeline and bid opportunities really across All three segments, Defense Solutions, Civil and Health. On the margin front, we've been Communicating this for some time, health margins were overheated in 2020 2021.

Speaker 2

Those started to moderate down. You saw that in the Quarter that they're coming to a place that we believe is sustainable and then we can build off of that going forward. So What I would tell you is that's how we see Health playing out is in the mid teens as we've communicated. But we're very focused in the other two segments about continuing to drive margin expansion, Defense Solutions and Civil. So that's generally how we see the year playing out and hopefully that gives you enough additional color commentary.

Speaker 3

Yes.

Speaker 2

And then Roger, going back to the security products business and the supply chain there, what parts of that might you bring in house? Some of the manufacturing, we've had we've used a contract manufacturer for If you think about it for some of the lower level parts and then final assembly of some of the pieces of equipment. And with the Dynex organization and expertise we now have, And that's been part of our strategy and we are having the conversations about a manufacturing center of excellence, Which I think really is a great part of the evolution of the company. And so we can look at, if you will, larger manufacturing like the provision system, I'm sure you all go through and be very confident that we can build that well in house. Thanks so much.

Speaker 2

Yes. Thanks, Rob.

Operator

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

Speaker 5

Good morning, everyone, and thank you.

Speaker 6

Good morning.

Speaker 5

Just a follow-up maybe on Health and I know you don't guide on a segment basis, but can you give us the moving pieces as we think About your growth rate, you mentioned SSA in the quarter starting to contribute RHRP, how do we think about that incremental contribution in 2023 and What you're seeing from burn pit and then the offset from DHMSM?

Speaker 2

Well, you nailed all the big players there, Sheila, so you're on top of it. First of all, I mean, the SSA team did an outstanding job and couldn't be happier with the transition, the fact that the customer did the right thing, Let us get started in the Q4. We're off and running, and we expect that to be a significant contributor to growth In 2023, so that is solid. RHRP, finally, we feel very confident that, that will start to ramp up here Really at the tail end of the Q1, there'll be some activity in March, but think about that as building from Q2 onward through the rest So that gives us solid growth momentum. PackDAC, it's still again early.

Speaker 2

I'd say the team is doing excellent work in QTC. We the Got a little complicated last year because some of the pre discharge work went to multiple competitors. We also have the international work that we won that's ramping up this year. So I'd say that's We expect growth in that area, but more color on that as we get a quarter or 2 down the road. And then finally, DHMSM, This year, there's this I would say towards the tail end of the year, we've got to continue to work to offset that ramp down on the deployment side, but the teams have been doing Excellent work to expand the capabilities within the software that's been deployed.

Speaker 2

And so we're continuing to find opportunities to do that. Roger, if there's anything more you'd add there. No, not really. Although, Sheila, I'm sure you heard in the State of Union address that the President talked about burn pits and making sure that we took care of veterans. And so it has been slow but solid, And we would expect that momentum to continue throughout the year.

Speaker 2

That's more likely to affect volume than margin. But we've seen, again, Our volume hold up well in our exam business and look forward to another strong year.

Speaker 5

Okay. No, that's helpful. And then I wanted to talk about margins as well. Defense was solid in the quarter, but I think it was mainly civil that in Q3 and Q4 have seen really good performance there. So What's sort of going on?

Speaker 5

You mentioned larger programs, but I didn't think you had anything in particular there. So how do we think about Civil margins going forward? And What's the driver of the better performance in the second half of the year?

Speaker 2

Well, Civil, Again, we talked a little bit on the prepared remarks about the Security Products area seeing some ramp up. And that will Certain quarters will have more volume there, certain quarters will have less, but that is always a nice contributor. Steady performance in our Commercial Energy business that has Grown nicely quarter over quarter. It's higher margin work. Team does an excellent job there.

Speaker 2

And then just on the digital Modernization side, Aegis coming in, not one of our higher margin programs, but it's great base, a lot of employees going to work that helps absorb that we see in that unit as well. So and lastly, everybody has been focused on cost management, Sheila. That was kind of the mantra Across the company in the back half of the year, the Civil team got to give them kudos. They went above and beyond in finding opportunities where they could drive sustainably into the organization, and so we like how that performance is trending. Sheila, I would add, if I could, because I know you followed us for a long time.

Speaker 2

What's been great about our Civil business is that it's growing. And we have a base of business In that segment, that is sort of infrastructure support business. We run Antarctica, we've got the Hanford contract, we do some other work for DOE. And as great that work is, it traditionally does not carry the margin of the rest of the company. And so as Civil grows top line, you see the margin increase because we're adding new business sort of At the margin and the mix is shifting in Civil.

Speaker 2

So the more we grow Civil and we hold The infrastructure business is constant, the more growth in margin you're going to see and the team there has done a great job of growing.

Speaker 5

Great. Thank you very much.

Speaker 2

Yes. Thank you.

Operator

Our next question is from the line of Burt Zubin with Stifel. Please proceed with your questions.

Speaker 3

Hey, good morning.

Speaker 2

Good morning.

Speaker 3

Roger, maybe if I or Chris, maybe if I follow-up to an earlier Question, if we look across the portfolio at Leidos in 2023, just a couple items you've got, the continued aviation security recovery, you guys noted Growth in commercial energy, you're going to have the annualization of those SSA task orders, you have the Packback, Sentinel, DES, this is just to name a few, All of which I would think would be mid single growth mid single digit organic growth tailwinds. What are the offsetting mechanisms there That puts you down to that 2% to 5% range?

Speaker 2

You make it sound so easy, Bert. You're right. There are a lot of tailwinds, no doubt about it. We've always talked about the DHMSM program coming off the peak. One of by the way, I think one of the real marquee programs But we're better than half done now, and we will start to slow down as we have talked about in the past.

Speaker 2

And that program It's just been such a great performance program for us, both top line and bottom line and frankly, Delivering on time and on schedule to our soldiers. So that's one of the programs that's coming down. I would also point there's a couple Spots in our Intel business has been fairly public, the Focus Fox procurement process. And while that has Some room to go ahead of it still to see how that fully plays out. That's an area that could be put some pressure on revenue growth it doesn't go our way.

Speaker 2

And then, we lost a program a year ago, and this is how long things take, called items, UFS. And so The good news is the Intel leadership team did a great job throughout 2022 to continue to support the customer during transition, but now we're Fully rolled off that program, so that's a little bit of a headwind. But by and large, we've had great success on our recompetes, really love the team's performance there. There are a lot of tailwinds that are known, but we also have seen customer behavior take longer and especially if they're worried about The budget environment transitioning into government fiscal year 2024. So our hope is we'll build momentum through the year.

Speaker 2

We'll have some successes and we'll be

Speaker 3

Yes, that's super helpful. Thanks, Chris. Maybe One item, Roger, that you had talked about before and I thought gave some good color was on DES. Obviously, that has the ability to be A significant driver on the sales side for the company and you talked about that as being tens of 1,000,000 of dollars in 22 and then maybe doubling from that range in 2023 and then really starting to ramp by 2024. Is that still how you're looking at it or how should we think about the range of Potential outcomes for that contract this year?

Speaker 2

Yes, I think that's a good way to build your model. And I was with a customer yesterday, actually. We had a long meeting on the program. We all want to move fast. This is about transitioning Non combat support organizations to a new, what we call, DoDNet.

Speaker 2

And Well, we want to do it the right way. We want to do it when we're ready, and we all want to move fast because it will save money, it will help interoperability between all these Support agencies, but we want to do it the right way. We don't want to create a negative user experience For all the people that are supporting the military. And so the discussion was, well, okay, can we move up Some of the transformations and some of the transitions, and we're looking at that. So I think there is potential for it to be higher, But we're not guiding to that, and we will talk to you quarter by quarter as to what our success has been and whether we've been able to I will tell you, we're very enthusiastic about it in 'twenty four and 'twenty five as it fully ramps and we're doing these conversions.

Speaker 2

How much more than what you described we can do in 'twenty three, we have yet to see. But I can tell you the Customer wants to move fast. We want to move fast. But we all know, sometimes you move too fast and you create a negative user experience, You're really not serving the user well, and we don't want to get ahead of ourselves.

Speaker 3

Thanks. Yes. Thanks, Bert.

Operator

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

Speaker 3

I wanted to ask about the cash Well, guidance for 2023 and I think if you back out Section 174, I think it's kind of flattish year over year. I think the payroll tax goes away in 'twenty three. Is there any other sort of offsets to that or working capital maybe That are preventing that from being higher?

Speaker 2

Well, again, Matt, with the growth we've had and the growth that we see ahead of us, There are some investments modest investments in working capital for a few particular programs. If we're able to win a program like Fins, for example, There's an initial amount of equipment that you have to procure and bring onboard to support the customer. So there are a few things like that in our pipeline that we're anticipating. We finished the year at 58 days DSO, and that's good performance. I think there's Opportunities to drive that even lower and we're focused on that as a finance team with our lines of business leaders.

Speaker 2

So we thought we'd start the year at $700,000,000 I mean, it's not a never a slam dunk, but our focus is to continue to build momentum on the cash side. But Nothing out of the ordinary as it relates to working capital investment, but there are a few programs that we are anticipating needing some support As we win them and grow them.

Speaker 3

Got it. Thanks. And then I guess it sounds like you're doing some sort of contingency planning around if there's a shutdown. Are you willing to share what kind of quantify the impact would be if we do get a shutdown?

Speaker 2

Well, first of all, No, because we really haven't we haven't gotten to that level of planning where we've in order to have To quantify, we'd have to pick a date and then go through and figure out which programs would be deemed essential and which programs would not be deemed essential and then How we would go mitigating? What we do, and unfortunately, we have done this way too many times, As we get our contracts organization and we go through our 3,000 or so contracts and try to understand How each contract would perform in a government shutdown. And some are easy. They're deemed essential. We know those will continue.

Speaker 2

Some we know will not be deemed essential. And then, as part of our preparation, We start to have conversations with contracting officers about things that might be in the middle and work with them on ways that we could mitigate a shutdown. And it just behooves us to be prepared. And by the way, we have learned the better prepared we are, The less likely it is we'll ever use the plan, but we would never want to maybe McCarthy and the President Have a meeting. I think they're going to meet again in a couple of weeks.

Speaker 2

And if it comes out of that and we get to June and we're not prepared, Then we haven't done our job to manage through a government shutdown as best we can. And that's the process really that we have kicked off. And Unfortunately, we have done this before. So we have a pretty well developed playbook, and we have gotten our playbook out and dusted it off.

Speaker 3

Great. Thank you.

Speaker 2

Yes. Thanks, Matt.

Operator

The next question is from the line of Peter Amott with Baird. Please

Speaker 4

Yes. Good morning, Roger, Chris. Hey, Roger. Maybe you could just update us on how NGEN is doing. I think we are kind of expected to hear kind of a steady state in 2023 in terms of a ramp.

Speaker 4

What's your thoughts on that? NGEN? Yes.

Speaker 2

Yes. Well, it's pretty much fully ramped and You're really doing well. We were in full possession of the network. Peter, I know you know the program well, but our first task Was to take the custodianship of the Assure network, okay? So we've done that.

Speaker 2

Now the challenge Is to transform that network to modern technology. And we're in the process of keeping the call center up, Maintaining the network, trying to get the quality of service up while we move to the new environment. And there is opportunity, we believe this here for additional scope through special projects and on contract growth and task orders. We are starting to see some of that. I think we have talked in prior calls that was a little slow in coming, but We have talked to the Navy and frankly, I've talked to our program manager and we're starting to see some of that break free.

Speaker 2

We see lots of opportunities Where technology can add value to the user experience in the Navy, and so we're constantly making suggestions to the customer about things that can be done to improve the network and which would end up in growth for us, but more importantly, would end up in better quality of service for the user. Know, Chris, you want to add? No, I mean, first of all, we've got an outstanding team running that program, and it's our largest program, as you can imagine, And we're only a year, 18 months into this thing. So the best days are ahead of it. To Roger's point, we're clearly identifying areas where there We can help support the mission and the customer better, and that would lead to contractual actions and modifications.

Speaker 2

And Let's just say, of course, we're interested in pursuing that, but at the pace that makes sense for the customer. So we're hopeful that there's We'll continue to see growth and margin improvement around that program as it moves into next year and the year

Speaker 4

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

Speaker 2

Absolutely. And Peter, we're all smiling because we actually do have chat GPT in our environment And we debated whether we ought to talk about it. And it seems such a popular term now. And I guess Microsoft is going to put it under Bing and really make a super search engine out of it. But I think what everyone needs to understand is those technologies are available to anyone who wants to use them.

Speaker 2

And I think the benefit goes to those people who capitalize on Not only the money we spend internally, but the billions of technology money that's spent outside the company. And so we are very aggressively using Things like chat, GPT and other modern language, AI platforms. And We've deployed robotic process automation in accounting, like in Chris' area. I mean, Yes, we don't talk much about that. We're certainly doing it for customers.

Speaker 2

We're using it like to analyze images and all the applications that you can imagine. But we're also using it internally in our functions to be able to, if you will, use computers to do what we call The dull, the dirty and the dangerous, right, and free up the human, whether that be a financial analyst or an accountant Or an imagery analyst or even a linguist, right, in our linguistics program to do what the human does best, which is to add that Cognitive discernment and then let the computers crunch through The gigabytes and petabytes and terabytes of data that we now collect.

Operator

Appreciate the details. Thanks, Roger.

Speaker 1

Yes. Thanks, Peter.

Operator

The next question is from the line of Seth Seifman with JPMorgan. Please proceed with your question. Hey, thanks very much. Good morning, everyone. Good morning.

Speaker 4

I was wondering maybe if you could talk

Operator

a little bit about the 23 Omnibus and kind of how that set up your expectations for the growth that should be coming in the Dynex Programs, particularly in the 2024 timeframe?

Speaker 2

Yes. Okay. Those are 2, I would say, lightly linked subjects. So let me talk through them and I'll have Chris clean up after me when I make a mistake. But Given the year and what's going on, on the Hill, I think the omnibus is about the best we can expect.

Speaker 2

And My hope and our plan is, McCarthy and the President find a way to raise the debt ceiling long before The June date, the debt is really paying for past years, for Authorizations and appropriations that have already been made, commitments that the country has been made, and we're just funding the government. And That will probably fund it. We're hoping a little bit higher than the 2023 levels. I think we can count on that. And As you know, it's always a discussion between defense and non defense.

Speaker 2

And if we raise defense, then there's a group of elected officials who want to raise the non defense budget at the equal amount. And that may tamp down a little bit of The raise in defense, but we're coming off such a robust defense budget this year that I think we will all do okay. Now how does that roll into Dynetics? And again, if you were down in Huntsville and I'll describe a little bit what you would have seen is A lot of productions that are in low rate initial stage of the program, where we're building the first eight Pre production or production units that will be followed in 'twenty four by a fairly aggressive ramp And significant production. So we're talking instead of 1 a month, 1 a week, 2 a week.

Speaker 2

And we could go through the different programs. I won't do that now. Those monies are pretty much already authorized and appropriated, Okay. Not in every case, I won't go program by program. But if we get an omnibus, then the ramp that we talked about in December Is certain, because these are programs of records that will be fully funded.

Speaker 2

Yes. I won't go into all the scenarios if there is a debt ceiling or there is a recession and all the things that the government could do, which is certainly within the realm of possible. We think the high probability is they'll get an omnibus. It will have some growth in it. There may be a Ukraine supplemental Depending upon how it goes, and it certainly doesn't appear to be lessening.

Speaker 2

So they may cover those expenses with a supplemental as they have Done in the past. And then our production ramps in 'twenty four, which are Again, we're very pleased. I think they're very attractive. Those would be fully funded and we would see Significant growth in Dynex in 'twenty four, and I'll let Chris add to that. Not a lot to add.

Speaker 2

I mean, Seth, obviously, you can tell from Roger's comments, which were mostly focused towards The future in 'twenty four, we felt really good about how 'twenty three Omnibus came out, and our Allegiance Ferris team does an excellent job, and We clearly were making sure members understood the importance of some of our key programs, and we like the way we came out. You don't get everything funded at the level that you'd like, but on balance, we thought we came out exceptionally well and well protected with key programs And that sets us up nicely for this year.

Operator

Cool. Excellent. Okay. I'll leave it there for this morning, but thanks very much.

Speaker 2

Thank you. Thank you.

Operator

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

Speaker 7

Yes. Hi, good morning.

Speaker 3

Hey, good morning.

Speaker 7

Maybe for Chris or Roger, you did a really nice job Sort of sequentially first half to second half in 'twenty two on the margins. And I know you went through a number of items around your physical footprint, Some in sourcing, maybe some labor savings. But it also sounds like from the guide that in your comments that you're obviously not going to keep all of this. My question would be, how do you view sort of incremental sort of corporate level Cost opportunities as you look at the business into 'twenty three and how is the discussion with the customer in terms of How much you're able to keep? What's necessary to be competitive and win share in the marketplace?

Speaker 7

I mean, how do you view these dynamics into 'twenty three? And where are the incremental

Speaker 2

Well, Ken, let me get started. Roger might pile on. First of all, very proud of the team. Second half of the year, as a team, we really rallied and showed what we're capable of on the cost control margin improvement front. And quite honestly, that was despite the fact that we had some program areas where we could have done better.

Speaker 2

And so I think that gives us some confidence and momentum going into 'twenty three. Now couple of things to keep in mind. The Health Group overall for the year finished still above 17% on margins, right? So 4th quarter was Definitely more in line with what expectations are going forward. But earlier in the year, there was still some stronger performance from Caseload and QTC and other things that drove that higher.

Speaker 2

So that will still moderate down a bit, but we do intend to capture The savings and the margin upside that we've been able to realize in other parts of the business, and we're not done in Defense Solutions And in Civil, for sure. So and as we build our pricing, we have a rigorous process with our competitive intelligence team to kind of keep us in tune with Where we need to be on a price to win front, we factor that in and making sure that we can remain competitive while still trying to capture some of the margin upside. So The guidance is balanced for next year, and again, there's momentum there. I wouldn't say there's any super low hanging fruit On the cost reduction side, because we do focus on that continuously. But there's still more That we can do and we're focused on hitting that 10.5% long term margin target or greater by 2024.

Speaker 2

Yes. I don't have much to add, Ken. I'll make a couple of points that I'm not sure we got the footstamp. So taxes and interest, which I wish I could control, but I don't. That's like a $0.20 headwind on EPS.

Speaker 2

And we'll do all we can, and we've got a great tax department, and we'll see if we can mitigate that. Unfortunately, interest rates are up. And the way we manage our balance sheet, we're in the market. We're always replacing expiring debt instruments, and so that creates a headwind. But really, our philosophy is if we can grow revenue faster than we grow our indirect costs, then we get better every year.

Speaker 2

And so growing the top line has really helped us control costs. We had really good growth in the second half. Again, we expect continuous Growth for the rest of this year and then the challenge is to control costs Below revenue growth, but we've found like we have some costs That grow with the number of people, right? And so one of our thoughts are, we've had a business that was Somewhat dependent on people to grow, right? And we've talked in the past about, well, we want a little bit more product mix, we wanted A little bit more diversity in our portfolio.

Speaker 2

Part of that is so that we can grow non linear with people. And so if we have We get to the ramp in Dynetics where we're building more products. We can leverage our terrific workforce, but it's not one to 1 And that allows us to grow faster than our indirect rates. And you can think about HR and benefits and all the things, The training programs that we have with our people, that's just kind of our philosophy. And I think Chris did a good job of saying, we got fixed price and cost plus, and I'm sure you know how the mechanics are about what we have to give back based upon the contract type.

Speaker 7

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

Speaker 2

Yes. Thanks, Ken.

Operator

Our next question is from the line of Cai von Rumohr with Cowen and Company.

Speaker 8

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

Speaker 2

Well, Cai, I mean, keep in mind, First of all, half of our revenue is kind of Leidos content. We've got subcontractors, we've got Right. So that's only a portion of the business that you're focused on, the headcount growth. And that headcount growth that Roger talked about, the 2,400 people that we brought on Cheer was over the course of the year, right? We were adding them kind of pro rata throughout the year.

Speaker 2

So it's not like that's going to all be incremental Heading into 'twenty three. But that being said, we have big plans around the additional heads that we plan on adding again this year. So the combination of factors, headcount should be up, you're correct. There's payroll growth on top of that, that gives you Some upside, that immediately gets passed through on the cost reimbursable programs. You don't necessarily get uplift immediately on your fixed price But that's part of the equation too that would suggest if we're successful, we don't have any major losses and we To win our fair share, we like the momentum that we see on the growth side.

Speaker 8

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

Speaker 2

Yes, sure, Cai. And of course, it's early. So and we've got about 34 $1,000,000,000 of submits pending awards. And we had I don't know whether the Our submits of $23,000,000,000 last quarter was a record or not. I think it probably was.

Speaker 2

So we've got just a lot of things out there. And so we expect 'twenty three to be at or better where we were in 'twenty two. And, you know us, it's so early. We start leaning forward and then we get hit with a protest and the program gets pushed out of 23 to 2024, which we've certainly seen happen in the past. But we're we feel that 2023 is going to be Strong.

Speaker 2

And at the 'twenty two levels, we're better. There's always a couple of wildcards that says you will win. There are a couple, I would say, Maybe more sort of like one square over that we could win that would Really fuel the top end. We didn't really put those in our plans in our guide. What we're trying to do is to build a balanced guide around What we see in the portfolio and again, clearly above 1 for the year again, as it has been for years years years, But the potential for a very strong year and then we'll just we've got FANS, which still hasn't been awarded and We're hopeful that FINS will be awarded soon.

Speaker 2

I'll tell you, Kai, without going into the details, there's a program That has been under protest that we thought would be awarded in Q1 and the customer just asked us to extend our pricing 2 next year. So there's as enthusiastic as we are, every once in a while, we do get disappointed And the protest process and the adjudication of Court of Federal Claims tends to damp down some of our enthusiasm. And so in the Q1, we're going to be thoughtful about what we put out there. But you know the numbers 35, 36 in backlog, 34 awaiting award, your strong submits, and we'll have a very strong submit year In 'twenty three as well.

Speaker 8

Thank you very much.

Speaker 9

Yes. Thanks, Guy.

Operator

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

Speaker 9

Hey, good morning, everybody. Just want to follow-up there with a follow-up question to the line of thinking that Kai had there on the bookings. You mentioned in your prepared remarks the protracted acquisition process that's in place. That's something we've been hearing for Wondering if this is just kind of the normal environment now? And what's your assumptions are for the year?

Speaker 9

You expecting things to get better or worse on how quickly things can get Out in the bid and then awarded?

Speaker 2

Yes. I mean, I'll talk Kind of top level, Chris can add in is, and this is just what I think. So everybody has their opinion. There's a lot that's being written. What I think I'm seeing is customers wanting to get things under contract before We end up in this argument over the debt ceiling.

Speaker 2

With looming government shutdown, Who knows what comes out of those discussions? If you've got a customer and you've got appropriated funds, you're going to really work hard to get those committed between now June. And so we are seeing a little bit more activity and we're hopeful that these folks will try To move a little faster and get these things under contract. And then we probably end up with An agreement on debt ceiling with some kind of a future trade on some kind of a top level Budget constraint. I mean, I don't I'm not smart enough to know what that will look like.

Speaker 2

Last time this happened, we got sequester. But I suspect it will be something. Just what I read about how McCarthy got elected as Speaker, there is some kind of a budget Deal that's going to be cut for the long term, but that could be and I don't really understand how you balance the budget in 10 years. Again, that's not my job, but I run the numbers and it seems unbelievably difficult. But that's going to put a damper perhaps On what the budget could be, you're starting to talk now 25%, right?

Speaker 2

And so I suspect that If you have money and you have a program and you have a mission with requirements, you're going to work as hard as you can to get those things committed in 'twenty three. And I think that speaks well. And then as you know, we get an award in 'twenty three, that's a 'twenty four percent, 'twenty five percent, 'twenty six percent revenue. So again, our future, we think, is still looks relatively bright. And then plus the diversity in our portfolio, The civil group has been growing very strongly.

Speaker 2

The health group has been growing very strongly. So we've been working really hard to make Leidos Somewhat resistant to the vagaries of what happens from our elected officials. Chris, do you want anything? No, I think you covered it well. I mean, the only thing I'd say, we wish customer contracting shops were more fully staffed.

Speaker 2

They're not in many cases. One path that we think has been successful is more use of FedSIM. FedSIM runs a good acquisition process. The rules are well defined. And so we've

Speaker 9

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

Speaker 2

Yes. Good question, Jason. So it does. When we acquired that the Australian Airborne business, we knew they were kind of Halfway through a major investment in Mission Management System software capability, we're continuing that investment. So that will be completed in 'twenty three, but that was Fully factored in the valuation of the business, and so that's elevated for a period of time.

Speaker 2

Then as you know, I mean, just like the rest of Airborne business, there will be some Preventative maintenance, ongoing normal maintenance CapEx that will spend there over time. But think of that as slightly elevated in 'twenty three just to Continue the full development of that capability. And then we've got additional CapEx in that number for our U. S. Space airborne business as we're acquiring more capability, fitting it out to run more mission and we're optimistic on Some bids that we've put forward and some more that are in the pipeline there.

Speaker 9

Great. Thank you.

Speaker 2

Thanks, Jason. Rob, we're running a little bit over, but we

Speaker 1

have time for one quick question.

Operator

Sure. That will be coming from the line of Louis DiPalma with William Blair.

Speaker 6

Roger, Chris, Stuart and Gabe, good morning.

Speaker 2

Hey, Laurie. Good morning, Laurie.

Speaker 6

The success of drones in Ukraine and more recently, surveillance balloons have increased Congress' focus on Unmanned Systems. Last summer, you won a $300,000,000 contract to develop a medium unmanned Underseas vehicle for the Navy and your unmanned surface vessels, Sea Hunter and Seahawk have participated in Several successful demonstrations. Is there potential, Roger, for some of these Navy unmanned platforms to convert to programs of record or even for Leidos to provide Surveillance as a service similar to the COCO model that you're doing in the U. S. And in Australia?

Speaker 6

Thanks.

Speaker 2

Yes. Wow, that's great. I mean, Louis, you really are following things well, and I think you really understand our programs. I would add to that, we have Some unmanned vehicles that are made at Dynetics. By the way, we have some counter drone programs that We probably exposed you a little bit to when you were down in Huntsville, where we actually have a radar on Jeep and we launch a drone and it can go attack another drone.

Speaker 2

And so, but We see exactly what you see is the use of uninhabited vehicles Under the water, on the surface, in the air, and we'll call it, in the rare air, up between 60,000,80,000 First of all, I will tell you that it has been robust. There's been a lot of work already done. The MUUV is a program of record. So we won that. That's a program of record.

Speaker 2

It's fully funded. The Sea Hunter And the autonomous vehicles in the Navy are not yet programs of record, but the Navy is doing a lot of They're doing some things in the Mideast that have really demonstrated some capabilities. As you I have mentioned we've done a lot with Sea Hunter, Seahawk and Sea Innovator, and We believe there is a strong demand for those. I think for us, on the surface, the next thing Forrest may not be a full program of record, but they may buy additional vehicles to extend their experimentation, Which they can do under an OTA. That would happen much faster.

Speaker 2

But I believe that the Navy Is committed to having a significant percentage of their fleet, both unmanned and optionally manned. And Our autonomy software and the things that we have demonstrated really set us up well To capitalize on that and to bring them the capability that they need, there are a couple of other programs. There's mUSB, there's lUSB That are out there, they're going through their development processes. But to get all the way to the program of record, I think it's years away, but that doesn't mean that the Navy won't be spending funds to further their understanding And to experiment with, unmanned capabilities, and we would be right in the middle of those

Operator

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

Speaker 1

Thank you, Rob, for your assistance on this morning's call, and thank you all

Operator

Thank you. 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 Q4 2022
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