Greetings. Welcome to Leidos’ First Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone today should require assistance during the conference, please note, this conference is being recorded. At this time, I'll turn the conference over to Stuart Davis, Senior Vice President, Investor Relations. Stuart, you may now begin.

Thank you, Rob. And good morning, everyone. I'd like to welcome you to our first 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 will also find the earnings release and supplemental financial presentation slides that we'll use during today's call. Turning to Slide 2 of the presentation, today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. Finally, as shown on Slide 3, during the call, we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is included in today's press release and presentation slides. With that, I'll turn the call over to Roger Krone, who will begin on Slide 4.

Thank you, Stuart, and thank you all for joining us this morning. Our first quarter marked a strong start to 2022 with record levels of revenue and backlog, standing from our leadership position in the government technology market. We continue to build our reputation and track record of performance in digital technology, cyber, and innovative systems across our diversified, resilient business portfolio. Our strong first quarter results and the improving federal budget picture increase our confidence in delivering on our full-year financial commitments. I'll organize my remarks around four messages. 1. Our financial results demonstrate our ability to meet our commitments and outperform the market. 2. Our Business Development results are a testament to our differentiated position in the market. 3. Our consistent capital allocation approach drives shareholder value, and 4. We are able to attract the workforce we need and develop them for long-term success. 1. Our financial performance was strong at both the top and bottom lines. Revenues of $3.49 billion were up 5.4% in total and up 4.4% organically year-over-year, which is once again towards the top of the market. Non-GAAP diluted EPS for the quarter was $1.58 with an adjusted EBITDA margin of 10.2%. All three metrics were ahead of our plan for the quarter. Finally, we generated $93 million of cash flow from operations and free cash flow of $65 million. We remain on track to generate more than a billion dollars of operating cash flow this year. Number 2, Business Development sustained the momentum that drove our industry-leading organic growth last year. We achieved net bookings of $5.4 billion in the quarter, representing a book-to-bill ratio of 1.6. As a result, total backlog at the end of the quarter stood at a record $36.3 billion, which was up 11.6% year-over-year. The awards in the quarter were rich, with new business and takeaways balanced across our three segments and concentrated in key capability areas, including digital transformation and cyber. In civil, two large awards successfully completed lengthy protests. We won the $2.5 billion 10-year Advanced Enterprise Global Information Technology Solutions program, where we will provide communication, data center, cloud, and cybersecurity services across all of NASA's centers and facilities. For the FAA, we'll continue our more than 20 years of support on the National Aerospace Systems Integration Support Contract. The new NISSC contract is a single award IDIQ with a $1.7 billion ceiling across 10 years. Our work encompasses strategic and transition planning, flight procedures, security, and safety, data analytics, and unmanned aircraft systems in support of air traffic control modernization efforts. In Health, we won two multiple award IDIQs totaling about $1.7 billion over six and a half years to provide disability examinations for the Veterans Benefits Administration. The first was a re-compete for pre-discharge exams in the United States, and the second is a new area for us—exams outside the United States. Although we'll have more competition within our legacy business, we're excited about the opportunity to expand internationally. In Defense Solutions, our Gibbs and Cox subsidiary won a $319 million five-year award for ship design engineering services for the U.S. Navy's Future Service Combatant program. We also had a takeaway win on a $100 million single-award IDIQ to modernize the Army's gunnery training simulation systems. This work serves to enhance readiness across the operational spectrum in support of national defense. The biggest, most impactful win for the quarter is not included in our bookings. We were awarded the $11.5 billion Defense Enclave Services contract by the Defense Information Systems Agency. The DES contract is a 10-year digital modernization program focused on consolidating common IT services into a single-service provider framework. As expected, this award is now in protest with a GAO schedule to decide in mid-June. One of the keys to our BD success is our strategic partnerships, including with Amazon Web Services. I am proud that Leidos was awarded the AWS 2021 Public Sector Consulting Partner of the Year. AWS recognized Leidos with this honor because of our deep technical partnerships in areas such as edge to cloud and next-generation digital infrastructures to build solutions that drive digital and cloud transformation. This recognition illustrates the value of the Leidos Alliance Partner Network, which we founded in 2018, to deepen relationships with the most important vendor partners across our business groups. This network has fostered greater collaboration with partners to drive technology innovations and continues to be a differentiator for Leidos on a wide range of proposals and programs. Number 3, I view capital allocation as one of the keys to creating shareholder value. Last quarter, we talked about a greater focus in 2022 on share repurchase. And we followed through with a $500 million accelerated share repurchase. We set near our target leverage ratio, and our ability to generate cash gives us significant firepower for further capital deployment. We're well-positioned to grow and will continue to look for technology add-ons and strategic initiatives that bring us differentiated capabilities for customer access. We'll pursue large M&A only for a company that truly accelerates our strategy. 4. People are at the heart of what we do. And this quarter, we hired more than 2,600 people. One reason people are attracted to Leidos is that we enable our employees to build successful careers. We regularly review talent and plan development actions at all levels of the company. This quarter, we made several key moves at the Executive Leadership team and Board levels. We're pleased to welcome our new Chief Human Resources Officer, Maureen Watterson, who brings an impressive background and skill set to the Leidos team. Her excitement and commitment will enhance our people experience here at Leidos, with about 1,600 funded vacancies and an industry-wide shortage of cleared technical talent, recruiting and retention remain areas of strategic focus. Maureen will lead our human capital strategy and continue shaping the employee journey at Leidos through our Leidos Life Initiative. Dave King has decided to step back from his role as Dynetics Group President. He will continue in a consulting capacity, ensuring a smooth change to new leadership and advising on matters of strategic importance. I want to thank Dave for his outstanding contributions thus far and I look forward to working with him in his new capacity. Dave's Deputy, Steve Cook, is stepping up as Dynetics Group President. Steve's extensive experience and background, both with Dynetics for 13 years and leading critical programs for NASA before that, have prepared him well for his new role. He'll team with Paul Angola as his deputy. In addition, Paul will lead the national security space business for Leidos with a focus on space surveillance, missile warning, and space situational awareness. Next, our digital modernization business is growing rapidly with an expanding portfolio of differentiated technology. To meet the demands of our growing business, Steve Hall will move from his role as CIO to lead the enterprise and cyber solutions operation within the defense group. We've moved our CIO team under Chief Technology Officer, Jim Carlini, to tightly align our technology and CIO capabilities. Finally, Pat Shanahan has joined our Board of Directors. He served at the highest levels of government, including Deputy Secretary of Defense and Acting Secretary of Defense, and industry, including more than 30 years with Boeing, where he led supply chain and operations, commercial airplane programs, and many other relevant areas. While at DOD, he was a passionate champion of digital and technological advancement for the department, driving modernization in cybersecurity, AI, and cloud computing, as well as command, control, and communication. Pat’s wealth of expertise offers tremendous benefits for our shareholders and customers. Before turning the call over to Chris, I'd like to address the current congressional budget environment. Since the Q4 call, Congress passed the fiscal year 2022 omnibus spending package funding the federal government through the remainder of the fiscal year, with $782 billion in defense spending—a 5.6% increase from fiscal year '21—and $730 billion in non-defense spending, a 6.7% increase from fiscal year '21. The budget also includes $14 billion in emergency supplemental spending in support of Ukraine given the devastation at the hands of the Russians. It will take time for the new budgets to work their way into individual programs and new opportunities. But this provides positive momentum for the back half of 2022 and into 2023. President Biden has also released his $5.8 trillion fiscal year 2023 budget request. This request includes $813 billion in defense spending and $769 billion in non-defense spending. In addition to kicking off the fiscal year '23 congressional budget process, Congress remains focused on finalizing a $10 billion bipartisan COVID-19 relief measure and passing legislation to increase American competitiveness with China. Congress also continues to grapple with rising inflation rates, strained energy markets, supply chain issues, and the conflict in Ukraine. In closing, our thoughts are with the people of Ukraine and our colleagues who have family and friends in the country. The United Nations estimates that more than 11 million people are displaced. To help those impacted, we've made a significant donation to Project Hope to mobilize emergency teams and send medical supplies. The people of Ukraine have lost infrastructure that will take lifetimes to replace. When the war ends, it will only be the beginning of their struggle.

Thanks, Roger. And thanks to everyone for joining us today. As Roger said, Q1 was an outstanding quarter across the board, and I'm proud of the team for delivering such strong operating performance. Let's jump right into the first quarter results, beginning with the income statement on Slide 5. Revenues for the quarter were $3.49 billion, up 5.4% compared to the prior-year quarter. Revenues grew organically across all three reportable segments, given robust hiring and high labor utilization. Adjusted EBITDA was $358 million for the first quarter, which was down 8% year-over-year, and adjusted EBITDA margin decreased from 11.7% to 10.2% over the same period. Adjusted EBITDA was down primarily as a result of the $26 million net benefit related to the Mission Support Alliance joint venture recorded in the first quarter of fiscal year 2021, as well as a return to more normative indirect spending levels as we move past the pandemic. Non-GAAP net income was $223 million for the first quarter, which was down 10.4% year-over-year and non-GAAP diluted EPS for the quarter was $1.58, down 8.6% compared to the first quarter of fiscal year 2021. Interest expense was up $3 million year-over-year with the additional borrowing to fund the Gibbs and Cox acquisition and the $500 million accelerated share repurchase. The Non-GAAP estimated tax rate was 21.2%, which was in line with our expectations for the quarter but below the projected 23% for the year. The weighted average diluted share count for the quarter was 140 million shares compared to 144 million in the prior-year quarter. Now, for an overview of our segment results and key drivers on Slide 6. Defense Solutions revenues increased by 4.6% compared to the prior-year quarter. The largest growth drivers were the engine and if pick ramps, which more than offset the completion of the human landing system-based contract within Dynetics and the end of our Afghan support contracts. Defense Solutions Non-GAAP operating margin for the quarter came in at 8.1%, which was down compared to the prior-year quarter as the result of higher investments in developmental programs. Civil revenues increased 3.8% compared to the prior-year quarter. The revenue increase was primarily driven by volume growth on existing programs, including the support to Hanford and the FAA, as well as our engineering support to commercial energy providers. Civil Non-GAAP operating income margin was 7.7% compared to 12% in the prior-year quarter. The decline in segment profitability was primarily attributable to the MSA gain in the prior period, as well as the write-down taken on a minority interest joint venture program. Health revenues increased by 10% compared to the prior-year quarter. We continue to benefit from the ramp on the Military and Family Life Counseling program and saw a large year-over-year increase based on deployment timing. Health Non-GAAP operating income margin was 19.2% compared to 18.6% in the prior-year quarter. The improvement in segment profitability was primarily attributable to efficiencies introduced into procurement and delivery on certain contracts. As we've discussed previously, we expect Health segment margins to land in the mid-teens for the year. Turning now to cash flow and the balance sheet on Slide 7. Operating cash flow for the quarter was $93 million and free cash flow, which is net of capital expenditures, was $65 million. During the first quarter, we returned $577 million to shareholders, principally through the $500 million accelerated share repurchase program that we put in place two days after our February earnings call. We were immediately able to retire 4.5 million shares. The program will end within the next two weeks, and if our share price remains relatively constant, we'll retire another few hundred thousand shares at that time. We're funding the ASR with a combination of cash on-hand and proceeds from the issuance of commercial paper. When the Russians invaded Ukraine, the CP market became more volatile, so we sold some accounts receivable for short-term liquidity. Since then, CP markets have cleared and we've exited the AR monetization by quarter-end, so there was no impact on cash flow for the quarter. At quarter-end, we still had about $75 million of borrowings outstanding through our commercial paper program. As of April first 2022, we had $297 million in cash and cash equivalents and $5.1 billion of debt. We remain committed to a target leverage ratio of three times. Our long-term balanced capital deployment strategy remains the same and consists of being appropriately levered and maintaining our investment-grade rating, returning a quarterly dividend to our shareholders, reinvesting for growth, both organically and inorganically, and returning excess cash to shareholders in a tax-efficient manner. On now, to the forward outlook, as shown on Slide 8, we are maintaining our guidance for fiscal year 2022. Specifically, we expect revenues between $13.9 billion and $14.3 billion adjusted EBITDA margins between 10.3 and 10.5%, non-GAAP diluted earnings per share between $6.10 and $6.50, and cash from operations of $1 billion or greater. With three quarters to go, we believe the current ranges still encompass the likely outcomes for the year. That said, I will offer a few comments to help with modeling. On last quarter's call, I mentioned a range of EPS benefits from share repurchases. When we were implementing the plan, our stock was trading in the mid-'80s. We're now forecasting a volume weighted average share price of around $105. In addition, with world events, interest rates have risen and liquidity has tightened, which has increased borrowing costs. Given these factors, we are now projecting the addition from the Q1 ASR program to be closer to $0.10 than $0.20. In addition, we see the current environment as favorable towards growth, and we're exploring multiple opportunities where prudent investments could pay long-term benefits to Leidos and our shareholders. These increased investments may come in Business Development, R&D, and program execution. Finally, as Roger mentioned, we remain on track to generate a billion dollars of operating cash flow. As is our usual pattern, we expect the lion's share of operating cash flow will be generated in the back half of the year. We still believe that Congress will retroactively delay implementation of the new tax research costs, capitalization rules, given the number of members from both parties who have cosigned legislation to restore pro-innovation tax policy before the end of the year. However, if we were to amortize research costs and pay the taxes currently required, our operating cash flow target will be lower by approximately $150 million. With that, I'll turn the call over to Rob so we can take some questions.

Thank you. We'll now be conducting a question-and-answer session. One moment, please, while we poll for questions. Thank you. Our first question will be coming from the line of Peter Arment with Baird. Please proceed with your question.

Good morning, Roger and Chris.

Good morning, Peter.

Roger, maybe you could talk a little bit about how you're seeing the fiscal '22 enacted budget come in and certainly the outlook for '23 looks even better for when we're talking about the longer-term budgets. Just kind of in the context of how you think Leidos is faring there. And when I think about just also the Dynetics business and you talked a lot about the program and records, the outlook there. If you could give any kind of insight and is there any potential benefit from activity in Ukraine? I know you do have some area defense type products where you envision benefits.

Peter, you broke up in the last sentence or two.

Just regarding Ukraine.

Yes, okay, great. Let me talk in general. First of all, on Ukraine. Yes, we're probably seeing higher operational tempo in our defense sector because of support that the U.S. is giving to the effort and the supplemental spending. But that being said, the conflict, I think long-term is probably bad for the industry. We're not in the business of war; we're in the business of providing a deterrent. So, I think we will spend money now, but we will take it away from the future, and I think it's also bad for the country. Certainly bad, I think, for Europe, and I think it's really bad for the global community. We're seeing more stratification of nations and going back to a tripolar world, and I'm not sure that's really good for anyone. That being said, we've probably worked more overtime, which meant our costs probably went down because we've got more direct labor that we didn't plan for. And yes, there are some programs that appear to be accelerated because of some of the emerging threats that were used in Ukraine, hypersonics comes to mind. But we have the Indirect Fires program, which we expect to be fully supported. To the extent that anybody is in the weapons business—and we don't have a significant weapons business—but some of our peers that make munitions like switchblades and javelins and things like that, those inventories and that stock will have to be replenished. I think the broader view is, every time we get comfortable that we can lower the defense budget because peace has broken out across the world, we learn that the world is still a very complicated place and we end up having to reinstate the money back into the defense budget. So, I think the long-term prospect is that we will see a strong defense budget for the foreseeable future. And what's especially good for us at Leidos is that as the defense budget has moved up, there now seems to be almost an iron bar between the defense side and the civil side. We rarely now see increases on the defense side without a commensurate increase in the civil side, which really provides us a benefit across all of our segments. As I said in my comments, we will start to see the money flow through that PBB system in the second half of '22 and then '23 looks like it's going to be another strong year on both sides. And frankly, '24 will follow. I just think we're at a place relative to government spending that's going to favor our industry. So, thanks for your question, Peter.

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

Morning Roger, Chris. Thank you.

Good morning, Sheila.

Morning. Good quarter. Chris, you mentioned in your comments, R&D investment in program execution investment if need be. Was this regarding specific program updates or is it broader? And just in regards to profitability for the year, are you seeing costs come back or how do we see the cadence of profitability? Does it step up from Q1 levels?

Right. Thanks, Sheila. So, it's more than a singular program. In fact, it's been a variety of opportunities. We encourage our teams to be creative and bring forward business cases, where they see opportunities that could lead to longer-term payoffs, and we've seen a number of those opportunities. Some on programs that we're performing on, where we're all-in to make sure we deliver on time and on schedule and on budget. We believe those performances on those programs will lead to future opportunities with those customers. That's one example, but there are also areas where we see next generation of certain technologies that we want to continue to invest in because we believe the demand will be there. As it relates to the pattern of profitability through the year, we always had an expectation that that would build as we progress through the year for a variety of factors. Some of which is just the timing that we have visibility into program performance; product deliveries are a little bit more back-end loaded over the course of the year. Programs like maybe NextGen, which has been ramping up very nicely. There's more project work now that we're into that program, and the team sees opportunities as we move to the back half of the year to continue to deliver for the Navy customer. I think the pattern will see some modest increases over the course of the year, and that will counterbalance some of the things we're seeing in Health, where the margins were a little bit inflated in the first quarter as you saw. But as far as the close on your indirect spending question, it's not a surprise to us. We certainly anticipated getting back to being on the road and being involved with trade shows as necessary. So, as we built our pricing rates for the year, we certainly incorporated those expectations.

Thank you.

Thank you.

Thanks, Sheila.

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

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

Sure, Cai. It varies on the funding. Right now, I would tell you, other than one particular example that comes to mind where we wish there was a little bit more immediate funding on a particular program with one of our customers, funding hasn't been an issue. Some of the orders that we won, notably on the VBA contracts, that funding will be there over time. It’s just the way it gets recorded, so we don’t see funding as an issue. In fact, we’re starting to see some customers come to us and say they’re anticipating more funding being available on specific programs. What types of things could we potentially do? So that’s the way we're seeing things play out. And I’m sorry, the second part of your question was on the progression of revenue and earnings?

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

Right. It's a modest uptick as we see the year playing out; obviously, we just got started. Roger talked about our AEGIS award program, so there was really no contribution of that in the first quarter. That will start to contribute more in the second and build through the second half of the year. There are obviously some other new start programs that we just talked about. One of the key variables will be within health and how we see the exam volume moderating, but we've certainly anticipated that coming back down to the more normative levels that we've discussed. Think about steady uptick in the run rate, with the growth rate moderating as you know the back half of last year was a little bit stronger, so you'll see those growth rates dial down. And that I think margin profile will continue modest increases over the course of the year.

Hey, Cai. I would add on the funding side. When we start some of these very, very large programs, getting the billing process where we aggregate bills and getting the contracting officer and that whole process to work as smoothly as it will on a mature program takes us a couple of cycles. And so it's not the availability of funding at the customer level; it's getting the process of submitting invoices, aggregating invoices, and working with contracting officers—some of which are new to us because these are new programs—and just getting that process to operate as efficiently as we do on our more mature programs. So, we expect as the year goes on, that you will see that reverse.

Thank you.

Thank you.

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

Hi, good morning.

Good morning.

Hey Rob.

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

There is more proposal activity, and we're out on the road more; we're engaged with customers more. But like any acquisition process, when you essentially come to a stop, getting it started again, so there's RFI, there's an RFP cycle, and it just takes time. Air traffic in the U.S. is at or better than, and international is still lagging. In certain regions, there's still lagging, but our team is traveling again. In fact, the Group President has been overseas talking to airports, and the airports are now coming forward with new forward plans post-COVID, which will include a modernization of both checkpoint baggage. We've been investing in technology. We're trying to get to a touchless passenger experience, which I think is kind of the Holy Grail of all of us who want to go through airports. But that's just going to take time. So the recovery has been slow, and it's going to take us well into '23 before we get back.

Okay. And can you remind us what the domestic versus international split is in that business? And then Chris, I have a quick one for you.

Rob, I don't know that we've given a precise estimate of that. Because it ebbs and flows, right? Where the demand signal comes from at the service. But these days, it's less internationally focused, a little bit more domestically focused. But to my earlier point, where we see that bounce back in that future demand will be more internationally focused when that does occur.

I'd probably should've asked about the installed base. Maybe that's the better way to think about it.

We're going to test this now. There is more installed base internationally.

Okay.

Just on backlog, how much of that is fixed price and to what extent do those contracts have annual escalators like CPI or ECI to protect a bit? Well, the large awards in health this quarter are like a fixed unit rate pricing. I would tell you, while we don't have necessarily escalator protection, we spent a lot of time in our pricing building in the forward rates, and oftentimes those are prescriptive assumptions by the customer. If things deviate, you have an opportunity to revisit that. But we take that estimate of inflationary cost increases into consideration when building up our price on. As far as the overall, our fixed-price concentration hasn't moved much as a percent of revenue. So you're seeing the new orders come in along the same lines of what we've seen historically.

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

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

Sure. Thank you.

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

Hey, good morning.

Good morning, Gavin.

Morning, Gavin.

Maybe just a follow-on the inflation question. Roger, a couple of quarters ago, you made the point that the customer doesn't necessarily— the customer will lose purchasing power if they don't raise their budget for inflation. Seems like now we have a placeholder for inflation in the DoD Fiscal 23 budget. So, is it your sense that the government customer is cognizant of the inflation environment both in terms of real purchasing power and cost inputs?

Well, let's see. It's hard for me to judge whether the government customer writ large understands the complete impact of inflation versus a real growth in their budget. Certainly a variety of customers that we talk to. I would point out, Gavin. The fuel costs are an immediate problem for, say, the Department of Defense, especially as they have increased operational tempo and they have to buy the fuel that comes out of the working capital fund. There are a variety of things that are happening in the macro economy that are going to cap down sort of the enthusiasm on the top-line increase. My view is that at the SEC depth level, they completely understand that. I don't think they are going to get supplemental funding for inflation. They are thinking through the impact to the overall budget as they look at '23 and '24. But I'll just share with you what the rhetoric is around town here in Washington: we will not sustain inflation at this rate. As we come out of the back of the pandemic, as we get to whatever normal is, and with Ukraine...

Inflation will come down. Maybe not to pre-COVID levels, but it won't sustain at this level. I know there's a lot of focus on quarter-by-quarter of these numbers. But the economists that I talk to and the reports that I'm reading suggest this will temper over the next quarter or two, back to a more normal level, which will give them a little bit more real top-line.

Okay. Appreciate that insight. Then maybe just in terms of reiterating guidance, seems like you've de-risked a lot of the risk factors that were originally in place when you guided. Could you talk a little bit about what the moving pieces are that would take you towards the higher or lower end of the range for the year?

Yeah. I'll start and Chris can add. What we said is we're still within the range that we have put out in the marketplace, although there are obviously pluses and minuses. I made a comment in my prepared remarks that a lot of risk has been retired, and we have more confidence in our ability to meet our numbers for the year. But it's the first quarter, and there's a lot of uncertainty. I don't know what's going to happen in Ukraine. You should take away the fact that we're still bounded by our guidance. The team here is certainly a lot more confident than we were when we talked to you at first quarter, when we didn't have a budget, we didn't know about Defense Enclave Services, and we hadn't gotten out of the ages of protest. So there's a lot of good things going on from a forecast standpoint within Leidos, but we're still clearly within our upper and lower bounds in our guidance range.

Yeah Gavin, that's certainly the thought process that we went through, and we're a lot more confident now. We've learned from last year that things could evolve. The speed at which we think the positive budget environment flows through to orders we’ll have to watch that carefully over here the next couple of months. There's some exciting new programs that we’ve been bidding on. Depending upon those decision timings over the next two to three months could certainly be positive catalysts for us. But at this point in time, we feel we're still within the ranges for the year, and so it was premature to think about changing that at this time.

Makes sense. Thank you.

Thanks, Gavin.

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

Thanks very much. Good morning.

Good morning, Seth.

Good morning, Seth.

Just wanted to start off with health and the profitability there. I know that nearly 20% is not necessarily a normalized margin. But if it’s better than what was a very high-margin last year, I guess. How should we think about what’s going to cause that to decline? I saw there was a win on the medical exam contract in the quarter. You'd probably have a little bit more visibility there. Were medical exams down year-on-year and the margin rate still went up? If so, what drove that? And do the drivers give you an ability to maybe sustain something that's closer to those high counts?

Yes. So let me start and Roger can pile on. For the first quarter, we're not featuring the exam business as the primary driver for strong margins. I have to give it to the Dim Sum team. They're just doing an excellent job, and we saw, again, as they've deployed more, they're seeing more efficiencies. We've talked about procurement and delivery in our prepared remarks. How we’re delivering software for the customer finds opportunities to get more efficient, and they’re doing so. That one really helped contribute in the quarter. That was a little bit of a one-time pickup, but actually, it will help us on an ongoing basis maintain a little bit of a margin profile there. The exam business is doing well. I would say largely about the same levels that where we were a year ago. If you read carefully our prepared remarks, we talked about two things. Number 1, we're excited to have won a position internationally, which provides an opportunity to expand that business in an area we haven't been before. On the flip side, on one of our regions, one of the areas we perform on, we were re-awarded that contract, but they also added a couple additional suppliers, potentially to the mix. We don’t know how that dynamic will play out as far as how the case load gets distributed there, so that's certainly an area that we'll have to watch and moderate and could potentially pressure down on margins over the course of the year, but we'll just have to wait and see.

Yeah, Seth, I’ll just add a little bit of color on the number of exams we do per day, per week, maintained strong through the period. The discussions that we've had with the customer is there’s potential this year and next year that they will go back and review. They call these prior presumptive cases—things related to service that might sustain the volume of the exam business sort of above what we have forecasted. We've had those discussions with the customers. We haven't seen the volume come all the way through yet, so it's a bit of wait and see. The district six, which is your transition exam when you lead active military and you go to VA, they added actually two more contractors because of the anticipation that there will be added volume through these presumptive cases. It's really, really important for our customer to provide timely medical exams to the people who served the country. They want to add more capacity into the system because we think we’ll have more exams, and we’ll just have to wait and see how it plays out.

Okay. Great. Thanks. And then, just as a quick follow-up. It seems like the company is in a pretty strong place with regard to the revenue outlook for the year. With regard to the margin guidance, it seems that margin rates had expanded through the year, but health has probably had an unsustainable level in Q1, and you talked about some more investments. So what's the driver of an improving margin rate?

There are a variety of things, Seth. First of all, on the investment questions, if we see smart investments, we believe for the long term, we're going to fund those even if they were over and above the plan. But as of right now, obviously, we are holding to our guidance. I talked about some of the product deliveries. Although, as Roger alluded to, the SDA business is not where we hope it will be, we are still shipping some products and those are more back-end loaded over the course of the year. We'll be ramping up some new program wins; that scale will continue to increase the engine. Project work is back-end loaded, and some of the projects Dynetics is working on and delivering; we are anticipating better performance over the back half of the year. There are a variety of factors across the portfolio. We’re not far off obviously at a 10.5% margin; we’re not far off what our goals are. You're right. And we're preparing for health moderating down, and the other parts of the portfolio, moderating up a little bit this year.

Thanks very much.

Thank you.

Our next question comes from the line of Bert Subin with Stifel, please proceed with your question.

Hey, good morning.

Hey, good morning. Hey, Bert.

So following up on the SD&A question, Roger, you said last quarter normalization was something in the ballpark of several hundred million higher. So you could see up to or greater than a 2.0 organic tailwind for that business heading into 2023, could you not?

Without doing the math in my head—

Well, yes. It all bounced back overnight, right? We're not expecting that we'll get a step function increase, but that's where we think we'll ultimately be able to get back to.

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

Sure. We make the common hypersonic glide body down at Dynetics in Huntsville and we have delivered our first Leidos-manufactured common hypersonic glide body to the customer. We are ramping up production. I can't share what the production numbers are, but it’s a fairly steep ramp. The program is fully funded. We also won—we've talked about this in the past—the thermal protection system contract. This is the coating that goes on the outside of the common hypersonic glide body. So, we're producing and manufacturing the thermal protection system. I will say this: we have ample capacity to raise our rates significantly above what we're contracted for. And then we also make the launcher, which is more associated with the parent program, the long-range hypersonic weapon. We had delivered our first tranche of launchers in there, with the Army doing training. We're in a position to build additional launchers, and as those contracts get written. We're excited about the program. We believe there is a huge near-term need, and although we're conservative in what we put in our financial forecast, we clearly think there’s upside on the hypersonic business.

But we’re really excited. The team is doing a great job. In fact, Roger, myself, and a few other executives are getting on a plane later today to fly down to Huntsville and celebrate some of the recent successes they’ve had because they’re really knocking it out of the park.

Thanks, Roger. Thanks Chris.

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

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

Hey. Good morning.

I wanted to ask about the DAZ. And realizing that that program’s still under protest. But assuming that does come back to you at some point later this year, how should we think about kind of the pacing of how fast that could ramp up? And ultimately, what's sort of the run rate we should expect on that program?

Yeah. Well, I'll give you an overview and then Chris can sharpen the numbers part of it. We're in protest. We're optimistic that the GAO will rule on time; it clearly could go to another round of protest. Should go to the quarter Federal Claims. But it is a very slow ramp. Let me describe the program: this is taking over more IT environments to come to a common network approach across DOD. We will transform networks of other DOD agencies outside of the services and this happens on an agency-by-agency basis. The first couple of agencies that we will transform are relatively small. If we come out of a protest in June, the revenue this year is very small—almost double digits but not much more than that. And then it builds over time. I would caution dividing 11.5 by 10 and putting a billion-dollar in your model. We have to win and achieve that. I mean, there is potential to do that several years out, but it's not at that level in our models. It’s smaller than that. That's an IDIQ ceiling. If you're familiar with how that contract works, that gives the customer room to grow and spend at that level. But from our own internal modeling, it will be a slow ramp and will actually take years to become a significant program at that level.

I mean, Matt, I'm probably going to dodge your question even more. Obviously, we don't want to get ahead of ourselves. Very excited to get the win notification and have a high degree of confidence in our team. They know how to defend protests. So we're going to go through that process and see what happens in June. To Roger’s point, I feel like this is a program that will continue to drive growth for multiple years. That’s the good news. We’ll do everything we can to deliver for the customer and maximize the value of the contract because that means we’re really delivering great capability to up to 22 agencies within the DoD Fourth Estate. But think about this potentially: it will become, we believe, one of our top programs but don’t expect that in '23 and probably not in '24. It will take multiple years to get there.

Got it. Thanks, that's helpful. And then if I could just do one more on kind of the hiring environment and you guys have had won a lot of new work here. What are you seeing? Is it getting any easier to hire people? And are you confident you can get enough people to support all this new work?

It's really interesting. We’re a people company, and clearly, every day—almost every hour—we're talking about people and hiring. The great resignation means people are moving. If they’re resigning from Leidos, they’re going to work someplace else. If they’re resigning from someplace else, they are coming to work at Leidos. Our acceptances are in the 90% of the offers we make. We fill most of our positions between 30 and 45 days. So it’s not a hiring problem; it’s a retention problem. We all have it. I've got kids coming out of COVID. People are looking around; they want to try something different. We’re doing a lot. If you were in our meetings, we have a great talent acquisition team. They are doing a great job, and we can always do better. But we're spending a lot of our time on how we continue to make Leidos an attractive place to not only come to work but to stay. This is career development; this is investing in the future of our employees. This is what we call upskilling: teaching them new languages like Python and things like that so that they can have a new job and stay at Leidos if you will. There’s a lot of work, and I know I was talking to some of our competitors, and they have the same problem. We’re all focusing on employee development—not so much from a hiring standpoint. But where there’s always a shortage of cleared computer science majors in the Intel world, that’s always going to be a challenge. But you should not listen to the great resignations; we’ve been very, very successful in attracting and hiring, and now our emphasis is on retention.

That's helpful. Thanks.

Thank you. The next question is from the line of Colin Canfield with Barclays, please proceed with your questions.

Hey, good morning. The growth this year, unchanged guidance suggests that you need to hit roughly 7% organic; that’s like 23, 24. So then as we look out over a multi-year period, what are some of the pain points that you guys are looking at split between headcount issues, supply chain? Really, what does it take to not achieve those levels?

Well, Colin, over a multi-year time horizon, things can go wrong and we've been talking about some of them here that Roger just featured: retention. It’s not a hiring issue per se; it’s certainly for making sure we can retain the people to have the headcount we need to achieve that level of growth. First of all, we put that multi-year guidance out in October. We knew when we put this year's guidance out that we were on the lower end of the range. We're off to a good start. We're not updating this year's guidance at this point in time. But we just talked about things like DES, a catalyst for future momentum. It then becomes, can you execute? Can you get the people on the supply chain? So we’re watching all those things very carefully. All indicators at this point in time are nothing would take us away from feeling like we can still achieve those longer-term objectives. So that’s the trajectory we’re on.

Colin, there are still some big opportunities we have to win. We’ve talked about the FENS program, which now been delayed to the fall. There are a series of multi-billion-dollar programs that are still in our pipeline. So we have to continue to do overdoing, hire the people, execute in the business development area, win the programs, and staff the programs. The customer has to fully fund. And right now, I think '22 and '23 look pretty solid. But if there is a big sea change, frankly, if we get into a war where the U.S. is actually involved, that’ll re-prioritize spending within the federal government. Maybe a way from long-term modernization to actual combat operations. We’re hopeful that won’t happen, but that could have a significant effect on how we view the future.

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

Yes. When we put together our CapEx plan for the year, all of our businesses have a variety of needs, and there’s a laundry list of items. Some of the bigger ones were in the airborne ISR business, and that's an area we've made some investments and generated excellent returns with IRRs—certainly mid to high teens, if not better. We certainly look at the risks of an investment, we look at our weighted average cost of capital, and we try to generate returns, obviously, that exceed that. We are still putting money into—as much as we're trying to overall strengthen and densify our facility footprint. There are certain areas, especially in the intel space, new classified facilities we’re having to invest in some areas on the manufacturing side that we're investing. Facilities will probably be our second biggest expense area, and then it’s just a variety of smaller initiatives across the company.

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

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

Good morning, gentlemen.

Morning.

Morning.

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

So you're talking about, Mariana, our organic growth profile, and kind of dissecting that a little bit is what I think I heard from that question. We’re certainly seeing some uplift, and we look for what we call on-contract growth every year as we build our plan between inflationary pressures on cost-reimbursable programs and just because there’s capacity within contract budgets that we look for opportunities to continue to expand services to existing customers. That’s certainly an area that's contributing a couple of points of growth. At a minimum, we look for that and then obviously comes down to the New Star programs. We've talked, featured many of those. Engine will still be a growth story for us this year. Military Family Life Counseling continues to ramp up. We talked about AEGIS. So, some of those new mega programs are probably the next thing I would point to, to give us confidence on this year's growth trajectory. Roger just talked about the pipeline that is still rich, and we’re continuing to pursue multiple programs beyond that to fuel our growth. I'm not sure if that exactly hit on your question, but I'm happy to expand as necessary.

Now, that’s good color. And then via outreach through M&A, could you mind giving us some color on watching the pipeline in terms of how we are today and what companies, customers, or capabilities are you looking for on those packing or bolt-on acquisitions?

We won't give you too much in the way of specifics as far as what we’re looking at in the M&A arena, but I would tell you that a lot of properties continue to come to market. Roger talked last quarter about and followed up again this quarter: the mega properties, the larger ones are probably not something we have an immediate interest in unless we really saw a compelling case to accelerate our strategy. We’re certainly seeing some companies out of the space arena come to market. That’s interesting to follow. But we look at things that make sense to us. We assess things, but we're going to be thoughtful about where we engage. Back to Roger's prepared remarks, it really has to fit a strategy niche for us.

Yeah, Mariana, I would just foot stomp: We're really happy with our portfolio today, and so we look at M&A as a way to accelerate technology or customer access or relationship with a customer. We were fortunate to be able to do some larger transactions early, and it rounded out our portfolio. Now as we see technology advance, there are always a couple of areas where I think our time-to-market would be benefited by partnering with a company rather than trying to develop that internally. There are still customers in the federal space that we don't have a long-term relationship with, so if we're able to accelerate that relationship through another company that has a great portfolio, we will do that. Otherwise, as we said in our capital allocation, we're really thinking about how we get value back to our shareholders. So thanks for the question.

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

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

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