Greetings. Welcome to the Leidos Second 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. [Operator instructions] Please note, that today's conference is being recorded. At this time, I'll now turn the conference over to Stuart Davis, Senior Vice President, Investor Relations. Mr. Davis, you may begin.

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our second quarter 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 two of the presentation. Today's discussion contains forward-looking statements based on the environment as we currently see it and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. Finally, as shown on slide three, during the call we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is included in today's press release and presentation slides. With that, I'll turn the call over to Roger Krone, who will begin on slide four.

Thank you, Stuart, and thank you all for joining us this morning. Leidos remains on track for another year of solid organic growth and core business profitability. The affirmation of our Defense Enclave Services contract award by the Government Accountability Office demonstrates our leadership in digital modernization across the federal government, with strong demand for our technology solutions and services across our diversified business portfolio. We continue to execute on our disciplined and balanced capital allocation strategy to drive shareholder value. And we are proving our ability to compete successfully for talent with another quarter of robust hiring. I'll now expand on these four points. Number one, our financial performance for the quarter was strong, ahead of consensus at both the top and bottom lines. Revenues of $3.6 billion were up 4.3% in total and up 4% organically year-over-year. Non-GAAP diluted EPS for the quarter was also up 5% to $1.59, with an adjusted EBITDA margin of 10.2%. We also generated $40 million of cash flow from operations and are on track to generate at least $1 billion of operating cash flow this year. Number two, our business development results demonstrate our strong positioning in the government technology marketplace. We achieved net bookings of $2.2 billion in the quarter, representing a book-to-bill ratio of 0.6. Over the past 12 months, net bookings are $15.4 billion and book-to-bill is 1.1. Total backlog at the end of the quarter stood at $34.7 billion, which was up 4% year-over-year with funded backlog of $7.5 billion, up 5%. On a constant currency basis, backlog was $268 million higher. You can read about some of our awards in the press release, but let me highlight a few developments in the quarter. Most importantly the GAO affirmed $11.4 billion DES award to Leidos. We'll support DISA's…

Thanks Roger and thanks to everyone for joining us today. Second quarter results were very positive overall. And there are a number of moving pieces I want to cover this morning, starting with the income statement on Slide 5. Revenues for the quarter were $3.6 billion, up 4.3% compared to the prior year quarter. Revenues grew organically across all three reportable segments, given robust hiring and our recent program wins. Adjusted EBITDA was $366 million for the second quarter which was up 1.9% year-over-year and adjusted EBITDA margin decreased from 10.4% to 10.2% over the same period. Non-GAAP net income was $220 million for the second quarter which was up immaterially year-over-year. And non-GAAP diluted EPS for the quarter was $1.59 up 5% compared to the second quarter of fiscal year 2021. The performance of the base business is solid and stable. A couple of factors below EBITDA that drive EPS are worth noting. Net interest expense increased to $50 million from $46 million in the second quarter of fiscal 2021 with higher borrowing and the rise in interest rates. The weighted average diluted share count for the quarter was 138 million compared to 143 million in the prior year quarter. The current share count benefits from the retirement of 300,000 shares as part of the final settlement of the ASR program. Now for an overview of our segment results and key drivers on Slide Six. Defense Solutions revenues increased by 2.4% compared to the prior year quarter. The largest growth drivers were the NGEN and IFPC ramps which more than offset the end of our Afghanistan support contracts and reduced material purchases supporting hypersonics programs. In addition, the strengthening dollar represented about a $24 million year-over-year headwind for our UK and Australia businesses which lowered the segment growth rate…

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Peter Arment with Baird. Please proceed with your questions.

Yes. Good morning, Roger and Chris. Hey, Roger I guess you gave us some high-level color on the budget in the backdrop. I was wondering if just the way you look at it a longer term we're seeing the plus-ups. Do you think just given the wins that you've had your ability to that -- revenues could actually begin to accelerate as we think about longer term picture? I know you're not giving 2023 guidance but I appreciate any color? Thanks.

Yeah. We're still really optimistic about the out years. We made the comment I think both Chris and I that long-term, we don't see anything that changes the conversation that we've had in the past. And frankly since we were all together in New York last fall, the budget environment actually has gotten better and better in the areas where we're focused and differentiated. So I am still very bullish on the future.

And then just as a quick follow-up. Anything to highlight in terms of the Dynetics program of record outlook? It seems like that was -- continues to be something I think that's gaining a lot of attention.

Well, it's really exciting across the board. The hypersonic programs strong support. We have actually three Enduring Fires program, one with the laser, one with a missile and one with a high-powered microwave. And those are all strongly supported. The space business, there's things that hopefully we'll be able to talk about next quarter that are really great developments there. And we are -- I don't want to overemphasize this, but we're really, really pleased with how that has worked out. And of course that's why we chose it for the visit in the fall. And I can't wait to walk you through the plant and let you meet some of the team down there. I think you'll be really excited too.

Appreciate the detail. Thanks.

Yeah.

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

Hey, good morning and thank you.

Hi. Good morning, Sheila.

Good morning. Roger I appreciate your comments on talent hiring and your retention focus. When we look at your head count it was up 10% I believe year-over-year with organic growth of 4%. So maybe if you could square that disconnect for us a little bit.

We've got an emphasis to -- a little bit complicated. I'll try to make it very simple. Direct labor is really important to us. It's how we absorb lot of our costs. And so if we can have higher direct labor under the same revenue bucket that's a positive for us. So we're trying to increase the Leidos' content of the work we have across the board. Now I'll also tell you quarter-to-quarter month-to-month it's going to fluctuate. But we have a long-term effort to increase our content. And Sheila as you know significant part of our content is the work that our great people do every day. And so seeing headcount grow faster than revenue, we actually view that as a positive. That means we are implementing our strategy. And we're having success in attracting and retaining the people that we need to help us be successful.

Okay. Thank you. And then I wanted to ask about how the business has been very good. And maybe on two specific opportunities with burn pit currently facing some hurdles in the Senate, how do you think about that and how it could be potentially incremental to your VA medical business? And then the second with Cerner and their EHR Modernization program, it's currently paused again. What are your thoughts there and the opportunity for Leidos?

Yeah. Sheila this is Chris. I'll get started. Maybe Roger can comment on the VA program. Obviously, we're very pleased with the Health team and their ongoing performance. And we had told you in Q1 that we had won a recompete successfully that was critically important, although that there was an increased amount of competition introduced on that program. We also won some new work on international. So both of those dynamics are shaking their way out and we'll continue to see international ramp-up and we might see some pressure on the legacy side on the pre-discharge work. You talked about burn pit that's something we're watching very carefully. The team believes there is a significant increase in demand that will come from that. Obviously, we had hoped and expected that legislation would have passed by now. We're monitoring that daily, hourly and we hope to have some good news soon. So that's something that there is a modest amount of increased volume in the back half of the year associated with that coming through. And we think hopefully we'll be in a position where we could do better than that if things work through quickly. And Roger might comment on the VA.

Yes. And thanks Sheila. Obviously, we watch the VA program very closely. We have a relatively small role in supporting Cerner on the program. The movement of Cerner to Oracle, I think is going to be a positive for the program. Oracle is a real strong company, very strong software and data management. There's the Oracle Cloud. I think that will all be favorable for the VA. I know that they are paused while they reassess their go-forward plan. We stand ready to support Oracle, Cerner, the VA, any one of those organizations with the best of Leidos and frankly, members of our DHMSM team, and we'll just have to sit back and see how it develops. Again, I know they're paused. But the VA needs a single electronic healthcare record system and they need the interoperability with the active military, and we're strongly supportive of both of those.

Thank you very much.

You’re welcome.

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

Hey, good morning.

Good morning.

Good morning. Hey, Rob.

Roger, one thing that we're noticing with -- in your numbers today and also happened for Booz, but flat sequential sales in defense. And I wanted to ask, why we didn't see a sequential uptick from the March quarter to the June quarter, just given that the CR concluded in March? What's going on? Is it just slow acquisition activity out of the Pentagon? And why?

Yes. It is slow acquisition activity. It's a slow ramp on the programs that we've won. Of course, some of the programs that we won got protested, so they got pushed further into the year. Outlays are actually down. And I really can't -- I can't tell you why -- what's going on in the acquisition in the Pentagon, although we do talk to the Pentagon officials, head of Acquisition head of Research. They fully intend to spend the money. And they've got the money authorized and appropriated. I think they're a little bit like everyone that a lot of their talent retired. They're still working remote. So things are just taking longer. And then, something that's really important to us is, what we call special project work on a lot of our contracts. This is where we have a base contract with a defined statement of work and the customer says, gosh, why you're doing that? Well, could you do these other things? That's really beneficial to us, both from a top line and a bottom line. And that project work got delayed because of the budget uncertainty. And we're optimistic that we'll see more of that in the second half of the year. But we're cautious to forecast it, as you noticed in Chris' remarks. So I think overall there's good news. I think short-term, it's just kind of getting the machine, running again and getting them to spend the money.

Well, just on the back of that, is there anything particular about the types of awards that are being delayed or the size that are being delayed? Is it more common for larger awards and task orders to be delayed?

It was a good question. I'm kind of thinking of -- looking at Chris and...

I think that's typically what we would see, the larger, more complicated to evaluate, multiple competitors, longer EM, evaluation process. I think the -- where we do best is on-contract growth on existing vehicles. There's no competition. And again, there's hope that we'll see more of that come through in this -- in the fall quarter leading up the government fiscal year-end. But the more complicated procurements -- and you've seen that. I mean different agencies are different, but we've seen more consolidation into larger vehicles is often the case. And so those things can tend to push out the procurement cycle.

Yes. Okay.

Yes. And Rob, I would comment. And this is an absolute, but if a program is over $1 billion, I think the customer runs the acquisition process with the knowledge that there'll be a protest. So I think in both peer review and in writing the acquisition opinion and the sourcing letter, I think they're taking more time to get it right to either avoid the protest, which obviously hasn't been happening or to ensure that the award will be upheld. We've got protested again. It happens to us almost every quarter now in our large social security win. And I think in the government that they are now kind of like a protest is almost the normal and the bigger the program, the more likely the protest.

Okay. That's very helpful. I just wanted to ask you a clarification on the hiring. You said attrition is coming down. Is that because fewer people are going into the tech – that tech hiring is slowing I guess the best way to ask it.

Yes. Of course, I mean you and I are both speculating on why. I think there's a concern about the economy. Some of big tech has slowed their hiring. Some big tech has actually announced some layoffs. It's the summer and just a lot of people are on vacation or not. There is sort of a cycle and a seasonality to when people leave and when people stay. Very few people leave before like incentive awards are made in March. And I hope we're seeing a change in our long-term trend. But we've all been here before. It could spike back. We are still not back to pre-COVID levels. So although, we have started to see some moderation in attrition which I view as favorable but I do worry a little bit about the economy. And I'm not forecasting recession but I am forecasting maybe a little toning down in growth. So – and I think for a lot of people we have great jobs. We have great work. I mean we pay really great salaries. We have really cool stuff to do and we're able to attract some really great people. And I think once they get here and they start doing some of the fantastic stuff that we do, they go gosh, I want to do that. And that has that message has gotten through to our employees and I think we benefited from that.

Very helpful. Thank you.

Yes.

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

Hey, good morning.

Good morning, Gavin.

Roger, I think you said you didn't book anything for DES. But just any update on your expectations for what that ramp could look like or how much that could contribute in the future and whether or not that could ultimately be a top 10 program?

Yes. And DES, we've been turned on for the first task quarter which is very small. We are – let me spend at least 15, 20 seconds to describe the program. So in DES we work with DISA to create a common architecture called DoD ONE-Net. And once we've established that architecture then we will migrate 20-some-odd federal agencies to the new architecture. So the first thing we have to do is partner with our customer and define the architecture. And that is really hard work but a small number of people working in partnership with a DISA customer. And that's going to go on for months. So it's going to be really low. I don't think we put numbers out. But as I think I said not significant impact to top line or bottom line. Next year right, we started to do migrations. And then in the third year we do even more migration. So – and again I think we said this last quarter is that when we clear it – it was going to be a very slow ramp. But then it will ramp into a significant program. Whether we'll ever achieve the IDIQ value of $11.5 billion I guess we'll have to tune in 10 years from now. It has the potential to do that because we believe the architecture and the cost savings and the increased cybersecurity and the efficiency of this new DoD ONE-Net will be so advantageous to the government customers that people will want to migrate maybe even more agencies over time. But it's going to take a while to get there.

Okay. That's helpful. And maybe just in terms of margins. It looks like it was 9.9% in the quarter excluding the charges. Maybe if you could just give us kind of around the horn by segments what that looks like through the rest of the year with Health, down from these elevated levels maybe Defense and Civil, what those trajectories look like?

Yes, Gavin. We won't put too fine of a point on margins by segment but I think you've got it right. We've been signaling Health is an area that we would expect to moderate down. We still expect that to be the case. But again, we love the team's performance. We talked earlier about burn pit legislation. There are some dynamics there that could help us. But it will not run at these levels because there's been a couple of one-timers in Q1 and Q2 in Health. Civil I think again AEGIS was a program brand new start. We knew it was going to be certainly at the front end of this program, multiyear program on the lower margin range. And that will continue to ramp up. But Civil is also where we absorbed a lot of the legal charges that I talked about. So we see those margins trending better. We -- Roger spoke about some areas of improved activity in our security products business. I don't want to get ahead of ourselves but that's an area that I'd say the back half will be stronger than the first half on profitability and margins. And Civil is a well-run business overall. So I think the Civil performance should trend a little bit higher. And then Defense, quite honestly is probably -- over time, it will be higher. Whether that occurs in the back half of this year's TBD, I mean the special project work that Roger talked about is something that we'd love to see that come on at a higher volume. We're not yet seeing that and therefore don't anticipate that will change in the very near term. There is some transition. The Afghan work moderated down. There's some great airborne opportunities that the team is pursuing. That's something we hope to speak about in the future. That will be a growth catalyst and margin catalyst for us. But right now, I'd say probably along these -- this current trajectory on the defense margin side for the near term.

Okay. Thank you.

Thanks, Gavin.

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

Hey, good morning. Tying together perhaps Peter and Rob's question. Can you just discuss some of the bigger drivers of next year's growth acceleration? It sounds like the defense hardware pieces of Dynetics seem to be adding outsized lift. And obviously, I understand it takes time to get all the head count added and commercial aero are going to returns in 2024. I guess it's still a TBD given the kind of exposure that you guys have to widebody traffic. So maybe if you could tie together kind of what are your biggest uplifters into next year?

Yeah. I mean, Colin, we're early to get in detail about 2023, right? And we'll certainly speak about that more as we get to next year's guidance. But again, I think Roger talked about the budget backdrop is a foundational starting point and that's favorable. Therefore, the volume of things that we're seeing and bidding on continues to be strong and favorable. And so, defense activity is one that we've seen a lot of throughput in opportunities more Dig MOD opportunities more C4ISR opportunities. I mentioned hopefully some airborne opportunities where we've demonstrated a great capability that the customer is interested in seeing more of. Dynetics in the defense hardware side, absolutely ,there are some programs that will be ramping up. There's also some programs that will be moderating, as we transition towards proof of concept, completing demos and getting into hopefully a production cycle award which will probably be more likely 2024. And so those things all should do fine. Civil again, would probably be the aviation hardware accelerating growth, but not back to pre-COVID levels, but the trends are positive there. And more civil agency digital modernization opportunities we continue to see and bid on that we're pursuing. And the wildcard is Health. Now the one big catalyst that we've been waiting on is the Reserve Health Readiness program. We spoke about that for over a year now. That had been delayed. It was originally in this year's expectation. It's now fully out of any contribution for 2022. But we see that as a big program that we've already won and should ramp up nicely in 2023. So those are a few things that come to mind. But again, we'll talk in more detail about 2023 as we get to that time of the year.

Got it. And then a longer-term strategic question. But can you just talk about how you're preparing the business for a structurally impaired head count environment? Both you and Booz are kind of talking about IT cyclical benefits and a softer economy freeing up head count. But if you look at the population statistics, labor force participation isn't coming back and the US population growth is almost close to shrinking. So if you think about how you guys are structuring the business around kind of that environment?

Hey, Colin, I'll touch on it a little bit. I'm not sure we have enough time on the call to talk about all the things we're doing. But I think we all realize that we are in an era where there are going to be more jobs than people. I mean, it's just a fundamental structural problem. If you look at college grads and where we can source. And so that from a long-term standpoint talking with our HR and our leadership team, it's about okay, what can we automate, how can we put RPAs into our administrative and functional organizations and free the talent up, so that they can provide value-added goods and services to our customers? And then what is our new knowledge worker work look like in this industry? And then how do we hire them retain them upskill them right and grow them over time? And so we have a long long-term view of our labor strategy and how we want to take people and create multiple gates and multiple steps in their career. So, they graduate from college, they come here they pick up some stretch Thunkable credentials. They add another computer language. They pick up Python. They get a master's degree. We continue to invest in them. They continue to grow and move professionally. And they go wow I'm doing great work. I'm making competitive salary. And I see my career advancing at the company opportunities for growth and management. We're growing. And that's a terrific place to be where we're growing and hiring people. But we do realize that the world that I grew up in is no longer here. And we have to be very thoughtful about where we want to put our people and frankly maybe what we want to do with partners and what we want to do with automation.

And the only thing I'd add to that is again we've been talking about some of these businesses. But clearly we see as growth catalysts some of our businesses that are less head count-dependent. What's happening in Dynetics what's happening with the security products business. So, again, they're not a huge part of the portfolio but they'll becoming increasingly larger part of the portfolio over time.

Got it. Thanks for the color.

Thank you. Good questions.

Our next question comes from the line of Cai von Rumohr with Cowen. Please proceed with your question.

Yes. Thank you. So, you and Booz had some trends that were very similar; strong sales a very anemic bookings although very strong fundings which I don't understand how you get those two together; and very weak cash which slips into the next quarter. Maybe give us some color on how we could get the see the incongruity of bookings and funding. And then looking forward, we've got all that funding is there are we going to have the super blowout September quarter in bookings that we could, or is that still going to be slowed by the issues you discussed Roger?

Yes. So, Cai I think the next quarter will be better, but I don't see the super blowout. I think and clearly Booz and all the other competitors we all work in the same industry. We're all facing the same acquisition issues. A point I would make which is something I can speak to from Leidos, I don't know about the other companies is our win rates are about the same, right? We didn't lose a lot of programs in first quarter or second quarter. There wasn't a lot of opportunities that were canceled, right? Things just moved to the right. And we saw that across our entire value stream. Again, as you pointed out some of our cash payments that we thought were going to happen in the quarter got paid in the first week or two of July. Chris talked about that being I think over $100 million. And it's just the process in the customer is slow. And we -- and I'll go back -- and then we got a couple of protests which really hurt our book-to-bill. But we kind of plan those. Every once in a while we get surprise. We don't get a protest, but more likely than not we get a protest. And that -- the social security bid probably won't turn around provided we prevail in the protest not until third quarter but in fourth quarter. So, that's not really going to give us much lift in third quarter. Again it should be stronger. But I think it is a slower ramp from the budget problems that we had earlier this year and the end of last year.

And I think Cai is increasingly we're talking about the mega awards the larger awards those just don't often line up with the government fiscal year-end third quarter cycle. So, you could see the bigger quarters any time like we had a great first quarter. On the funding side, I mean again I think that's conversion of previous prior awards unfunded to funded. That's not always going to follow the same cycle. It's easy for a contract officer to make that action on something they've already awarded and give you incremental funding dollars versus a whole new procurement decision process. So, to me, it's great. We like to see our funded backlog improving. But I don't think you can read too much into the cycle around when those activities take place versus brand-new award decisions.

Yes Cai. I think a good example is this program we call FENS, which is sort of a network infrastructure program for the FAA. A year ago, we thought it would have happened in first quarter and first quarter it got delayed to the second half of the year. Now it's a little bit uncertain, even when they're going to make the award, I think we can almost count on a protest. So if they make the award in the third quarter or fourth quarter, that could be extended well into 2023. And we just have that kind of uncertainty. And we've seen more of that trend, and more of that behavior perhaps than we have over the past couple of years.

Thank you. And can you give us just some quick color, on what are you seeing in terms of July? Is there being any pickup, or is it still at the same level? What are you seeing there?

Well, cash was good in July. From a war...

We have a couple of strategic wins. We'll be able to talk about that happening.

Yes, we did. They're not quite -- well they're not announceable, yet. Well, I always think every month, we have great wins. So I mean that's just sort of me. There's -- sometimes the wins, I'm most excited about probably don't make the print, because they're strategic and there is technology involved. And we had some of those in July that we'll be able to talk about in the next quarter. And -- but there was no mega win in July. Probably, our next biggest win on the horizon, there's a couple of programs there's a big IDIQ that might get award. But then we have to fight for tens score, it's probably that FAA FENS program.

Thank you very much.

Thank you.

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

Hi. Good morning, guys. Thanks for questions.

Good morning, Matt.

I wonder, if you could -- could you comment on your international business? So you did the acquisition in Australia. Obviously, a lot of our allies are talking about spending more on defense. Just curious, if that could be a bigger part of the business in the future.

Listen, we're really pleased with our international work. And we're a little under 10%, by revenue of dollars that come from outside the US, right? And -- but we're going to be very selective. We tend to follow the US, in five Whys. So we're strong in the UK and Australia has always been a traditionally strong market for us. And by the way, they are a terrific ally of the United States. They have fought, I think in every war alongside the US, since the turn of the century. So growing more in Australia, is definitely a priority for us. But we want to grow in the right way and think of us as kind of growing country by country. We want to be in a country, grow large enough where we're going to have infrastructure in critical mass, and then use that country to maybe move regionally. We are not going to be like some of our competitors, where we're big enough that we can have offices in every country. But we think -- the international, is a nice mix in the portfolio. It could be countercyclical, with some of the priorities within the US. And then I put into a whole different category, our SES business, our security business, which by its nature is global, I mean, it's just -- the way that business works both at airports and ports and borders. The machines are easily transportable. By the way the specs and the requirements, are relatively uniform. If you can put a provision at Dulles, you can put a provision in Hong Kong usually with small mods. And that equipment for us is, manufactured in the US and then we export it around the world. And around the world, looks to US, as the standard setter. So in the SES business, we're probably anomaly 125 countries. But it doesn't mean, that we have necessarily a large organization in those countries. We might have a field service tech and an airport. We might have a couple of people doing maintenance and support. And that business, I would tell you today, is already global and isn't going to become more global. We're about in every country, that we feel is appropriate for us to sell in I really understood your question to be more of okay, well you bought another business in Australia, which we think is a real positive. We're really excited about the business. It's a critical mission for the Australian government. And growing larger in Australia, is absolutely part of our strategy.

That's, great. And then, I guess, just one more on kind of DES and the long-term targets that you guys gave at the Investor Day, last fall. How much was DES included in that, not only from kind of, I guess, a growth standpoint, but also margins? And is -- any potential dilution from that contract we should think about as that program ramps up over the coming years?

Well, Matt, I would tell you that certainly in the near term that won't -- we don't expect the margins on that program to get at or above the corporate average. So we recognize there's some initial investment. In fact that's part of what we're seeing this year quite honestly is while we are in the protest process, the team was building out the PMO staff. They were getting ahead of transition working jump-start. So we're spending money on DES, and we'll continue to do so, because we're taking a big picture a long-term view on that. I would just tell you that I expect 2024 to be more of a significant contribution than 2023. So we've got this ramp-up that Roger spoke about. It's early so we can't give you a lot of precision on exactly the timing and customer adoption. But certainly by 2024, it should be a more significant part of the growth story for us.

Great. Thank you.

Thank you.

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

Hey, good morning and thank you for the time.

Hey, good morning.

Good morning, Bert.

Roger you noted that SD&A will not recover until 2024. You had previously guided that business, I guess, if we go back to early 2020 to low teens, annual sales growth with expanding margins back when you did that deal with L3. How should we think about the path forward for SD&A now? Does it get back on to that track, or are you really just sort of thinking about it in terms of pro forma 2019 sales?

No. The way we look at it is, we had a path when we bought the business and we signed the deal before COVID. And then we -- there's this huge trough in our revenue and it has affected margin too, although, it's still a nice margin business, right? And we hit bottom. And now we've seen it start to recover and we are seeing double-digit growth in that business year-over-year. In our forecast it will continue where in 2024, we'll hit the pre-COVID level and then it will continue to grow beyond that as airports both in the US and in the rest of the world end up modernizing their equipment, one, because of age, but secondly, because of evolving threat, which is new chemicals, fentanyl, other chemicals, meth that the old machines couldn't detect. What we call touchless is the big demand at airports as we all know is to be able to just walk through. And the technology is emerging where most airports 10 years from now will have a touchless experience for the passenger and we expect that to drive significant demand. I know I would go down a lane that was touchless versus one that was not.

Well, I think look at improved throughput right which is a huge deal.

And efficiencies. So -- and we have been during this sort of troughed area investing heavily in technology so that we are ready to compete as the business comes back.

Just a clarification question on that. Where does border security fit in? I know you have some products there and that seems like there's going to be a lot of future demand. Does this acquisition in Australia have any relation to what you might be doing in that business, or are they completely separate?

Yes. They're completely separate. So this is more -- the Australia business are airplanes with sensors flying over pretty much blue water and littoral water looking for boats that are in distress and maybe boats that shouldn't be there. And our other business is literally where you drive a car through, you drive a truck through. We have a rail business. We're at the Mexican border where the railcars go through one of our machine and then we do personnel screening. So they're very, very different. It is -- I think you are right. The customer when you go way to the top is the same in Australia, but it's probably a different organization of that customer. And we were not interested in the carbon business, because of a crossover to our SES business.

Got it. And then just a quick follow-up if I may. The appropriations process is likely to yield. I think you mentioned earlier Roger defense budget is higher than the initial request. But that's likely to put pressure on non-defense just in terms of thinking about total spending. Is that a good outcome in your view? I know you have pretty similar exposure to both.

Yes. First of all, let me tell you what I think is going to happen and then if you want an editorial of what do I think -- I use -- that too. I think that non-defense will move with defense. I don't think you get an omnibus without moving the non-defense budget in the same direction. I think that's what we've seen in the past couple of years. I think that's what will happen this year. And whether we do this in the lame duck which is what I think is going to happen and people are going to want to move non-defense and defense sort of in lockstep we will get an omnibus. It will get done before the next Congress comes in and we will move on. And I think that will be good for Leidos across the board both our Defense business, our Intel business our Health and Civil. Now if you ask me if that's good, by the way, I think it's good for the company. I think it's good for our employees and our shareholders. I have three-year-old kids and there are times where I wonder when we're going to have to pay this back. And that means maybe there's a tax increase sometime in the distant future or another source of revenue for the federal government. But from a Leidos standpoint, from an investor standpoint I expect the budget environment to be very, very healthy for us for years.

Thanks, Roger. Thanks, Chris.

Okay, Bert.

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

Hey, thanks very much and..

Hi, Tobey.

Hi. Its Seth. Just a quick one from me this morning keep it short. But the release mentions the reduction in materials intake at Dynetics as a driver for defense. Does that have to do with sort of scheduled changes in activity there, or is that more of a supply chain issue kind of as we've seen across the industry including at some companies in similar areas like Raytheon and Aerojet?

Yes. So Seth it – obviously, supply chain is a factor that we're seeing here and there. But the particular issue in hypersonics was kind of plan, the cycle production schedule for that program. It's following course that we expected it to. Now we're hopeful for some more authorizations from a funding perspective that could help the program. As a growth catalyst in 2023 that's something we're paying attention to. But right now there's not a big issue from a supply chain bottleneck although I would say that we're still not out of the woods on that as it relates to certain component parts in various parts of the business. But it hasn't been a major factor for us this quarter.

Right. Okay.

Thank you.

I will stick to one today. Thanks.

Great. Appreciate it.

Thank you. The final question is coming from the line of Tobey Sommer with Truist Securities. Please proceed with your question.

Hi. Good morning. This is actually Jasper Bibb on for Tobey. Thanks for taking our questions. So I just wanted to ask about margins in the Civil segment. I think you highlighted SG&A and the contract ramps there. But can you provide a bit more color on when you expect that segment to return to more normalized 2018-2019 profitability level?

Yes. That's certainly something we have ongoing discussion with the leadership team. And there's a lot of catalysts within the Civil business. Certainly, SES is a big part of the longer-term margin strategy. I've mentioned some of the nice program wins that we've had on the defense -- on the digital modernization side and those will be on the lower margin side in the near-term. Where we do really well on margins -- our commercial energy business has been a strong margin catalyst for Civil. We're continuing to see that grow although it's a smaller part of the portfolio. We do well in our transportation, aviation business with the FAA quite honestly. And that's subject to FAA budget environment new program starts. And the anchor is some of our MNO support contracts, mission ops whether that's with DOE or other customers are tend to be on the lower margin side. So I would say in the near-term to get back to those levels is probably a multiyear undertaking as we look to win and execute more Dig Mod portfolio and see SES rebound, but some small improvements in other parts of the portfolio or what we after with the team. So that's how we see it right now Jasper in the near-term.

Okay. I appreciate the detail. Thanks for taking my questions, guys.

Okay. Great. Thank you.

Thank you. We reach the end of our question-and-answer session. And I will now turn the floor back to Stuart Davis for closing remarks.

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

This will conclude today's conference. You may disconnect your lines at this time. Log off your webcast and have a wonderful day.