Greetings and welcome to the Leidos Quarter Three 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Stuart Davis, Senior Vice President, Investor Relations. Thank you, sir. You may begin.

Thank you, Maria. And good morning, everyone. I'd like to welcome you to our third 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 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 four.

Thank you, Stuart. And thank you all for joining us this morning. Our third quarter results demonstrate the momentum in our business as we continue to report revenue growth at the upper end of our guidance across our diversified portfolio. In addition, our dedicated team delivered earnings in excess of our forecast and generated the highest quarterly cash flow from operations in our history. These results position us well to deliver on our full year financial targets as we make the world safer, healthier, and more efficient. As usual, I'll touch on our financial performance, capital allocation, business development performance, and people. First, our financial performance for the quarter was strong and ahead of consensus at both the top and bottom lines. Record revenue of $3.61 billion was up 4% year-over-year. Adjusted EBITDA margin of 10.3% was up 10 basis points sequentially and non-GAAP diluted EPS came in above our forecast and consensus. Our third quarter performance and improved visibility enable us to raise our revenue outlook and derisk our earnings for the full year. We also generated a record $748 million of cash flow from operations. This puts us on track to meet our cash commitment for the year, strengthens our balance sheet, and positions us for future capital deployments to benefit shareholders. Which brings me to point number two, our approach to capital allocation. Yesterday, we closed our acquisition of Cobham Aviation Services, Australia's aviation Special Mission unit. This business provides border force airborne surveillance, marine safety search and rescue, and generates roughly $100 million in annual revenues. It is immediately accretive to both non-GAAP EPS and EBITDA margin. At this point in our strategic journey, the Cobham acquisition is a great example of what we're looking for. It expands market access, provides us franchise programs with a customer of strategic importance and complements our existing business, all at a multiple below ours and a price that enables our shareholders to benefit from future revenue and cost synergies. Our cash balance at the end of the quarter was $807 million as collections were especially strong in the back half of September to close out the government fiscal year. Our plan is not to accumulate cash. We just paid for the Cobham acquisition, and we'll be paying down some debt to move closer to our target leverage ratio of 3 times. Our balance sheet enables us to steadily deploy capital in productive ways. Given the strength of the company and a valuation that doesn't reflect our long history of driving steady earnings growth and cash generation, we'll lean towards share repurchase when we have deployable capital. Number three, our business development results demonstrate that our strong positioning in the government technology marketplace is enabling us to navigate a difficult environment. The current timelines continue to extend, and DoD outlays continue to lag budget authority. With net bookings of $4.1 billion in the quarter, we achieved a book-to-bill ratio of 1.1 and grew backlog to $35 billion or $35.4 billion on a constant currency basis. We also had nearly $1 billion of third quarter awards protested. Absent the protests, book-to-bill would have been 1.4. Highlighting some important awards. We received a five-year $1.5 billion task order to support the DoD with rapid technology insertion to enhance C5ISR missions globally. We expect to receive the full award value over the life of the contract. But in accordance with our policy, we only booked $100 million in the quarter. This award, known as Sentinel, is all about getting capabilities into theater and to the combatant commanders quickly. As a solution agnostic integrator, part of our role is to find innovative technologies that can be rapidly matured, proven and integrated in support of multi-domain operations. Sentinel fits within the Joint All-Domain Command and Control or JADC2 umbrella. Our positioning on JADC2 was also bolstered by the Air Force's selection of the Advanced Battle Management System Digital Infrastructure Consortium. With four other consortium members, Leidos will work to deliver the Air Force's vision for distributed battle management and decision advantage by enabling speed, security, and integration at scale. NAVSEA awarded Leidos a $358 million contract to design and build a medium-sized unmanned undersea vehicle to provide autonomous oceanographic sensing and data collection for operational intelligence as well as to support mine countermeasures. We also received our first task order on the $11.5 billion Defense Enclave Services contract. The $138 million task order will lay the framework and begin to consolidate, integrate and optimize five agencies on a common network architecture through digital modernization and transformation. We successfully completed the transition period and have assumed operational responsibility for DODNet and DISANet. And in a key win for our space business within Dynetics, we received a subcontract with Northrop Grumman to develop hypersonic defense sensors for the Space Development Agency. We have more than 40 years of experience developing and flying space-based electro-optical and infrared sensors and payloads for a variety of missions. Through this award, we'll develop and build the sensor payload for a proliferated constellation of low Earth orbit satellites for the Tranche 1 Tracking Layer. The Tracking Layer constellation will detect and track advanced hypersonic and ballistic missile threats as part of SDA's missile defense architecture. On the predecessor contract, our Tranche 0 payload is on schedule to launch by the end of the year. The Tranche 1 design will increase coverage area while reducing payload size, weight, and power. Eventually, these constellations of satellites will form the core of a new National Defense Space Architecture, providing global coverage and adding resiliency in the country's missile warning arena. As a reminder, we'll be hosting an investor site visit at Dynetics in Huntsville, Alabama on December 1. Please reach out to Stuart if you're interested in attending. And the final key win that I'll touch on this morning is the re-award of our IT support to the Social Security Administration. As of the second quarter call, our award was protested by the previous incumbent. And after a resubmission of proposals, the SSA re-awarded all of the work to Leidos. The incumbent once again protested the award, and the new GAO review period expires on January 3. Lastly, point number four. Leidos is an attractive destination for great talent. In the third quarter, we hired just over 2,800 people. Year to date, we've hired more than 9,000 people and increased headcount by more than 2,000. It's still early, but voluntary attrition is trending in the right direction, and we don't expect that staffing will significantly constrain our plans for next year. Our dedicated and capable people are a key differentiator for us and an important national asset. Before turning it over to Chris, let me touch on the federal budget landscape. As expected, the federal government is operating under a continuing resolution at last year's funding levels until December 16. Congress is still working on the appropriations and authorization bills for government fiscal year 2023. Nothing will get voted on until after the November 8 elections, but we expect that robust budgets will get passed before the end of the calendar year. Outlays are beginning to improve which bodes well for future growth. Chris, over to you.

Thanks, Roger. And thanks to everyone for joining us today. Third quarter results were positive and in line with the picture that we gave on the second quarter call. Turning to slide 5. Revenues for the quarter were $3.61 billion, up 4% compared to the prior-year quarter despite a currency translation headwind of $32 million. Adjusted EBITDA was $372 million for the third quarter for an adjusted EBITDA margin of 10.3%, which was up 10 basis points sequentially. Non-GAAP net income was $221 million or $1.59 per share. Non-GAAP net income and diluted EPS were down 15% and 12% respectively compared to the third quarter of fiscal year 2021, which had the highest earnings in our history, driven primarily by the COVID catchup in the business. Let me touch on a few of the below-the-line drivers. Net interest expense increased to $50 million from $47 million in the third quarter of fiscal year 2021 with 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, driven by the ASR we executed in the first half of the year. Finally, the non-GAAP effective tax rate for the quarter was 25.8%, up 170 basis points sequentially, which reflected the cumulative catchup for changes to the mix of revenues across foreign and state jurisdictions. The higher-than-expected tax rates lowered non-GAAP diluted EPS in the quarter by $0.04. Now for an overview of our segment results and key drivers on slide 6. Defense Solutions revenues increased by 3.3% compared to the prior-year quarter. The largest growth drivers were the ramps on the NGEN and various force protection programs, which more than offset the end of our Afghanistan support contracts and the foreign exchange headwind. Defense Solutions non-GAAP operating margin for the quarter came in at 8.1%. Civil revenues increased 10.4% compared to the prior-year quarter. The NASA AEGIS program was the primary revenue driver, but we also saw good growth in our security products and commercial energy businesses. The mix shift helped drive non-GAAP operating income margin to 11%, up from 9.6% in the prior-year quarter and the highest level in six quarters. Health revenues decreased 3.4% over the prior-year quarter. Revenue in the year-ago period benefited from the backlog of disability exams caused by COVID-19. Our share of certain exams has fallen with additional competitors added to one of our contracts. These factors outweighed another strong quarter on the DHMSM program. To this point, we have not seen much benefit from the PACT Act that was passed in the last quarter, although disability exam volumes remain high. Non-GAAP operating income margin came in at 15%, which is where we've been signaling all year. Turning now to cash flow and the balance sheet on slide 7. Operating cash flow for the quarter was $748 million and free cash flow was $721 million. These were record numbers for Leidos, and I'm tremendously proud of the team's focus and dedication. In addition, the government customers were looking to clear the decks at the end of their fiscal year and, in some cases, paid invoices that would normally have been collected in Q4. DSOs in the quarter came down 3 days sequentially to 58, which is our target level. Great effort by the entire team. During the third quarter, we returned $53 million to shareholders primarily through our ongoing dividend program. At the end of the quarter, we had $807 million in cash and cash equivalents and $5 billion of debt. We closed the Cobham Aviation Special Mission acquisition earlier this week for $214 million inclusive of the hedge that we had taken at the signing of the definitive agreement. In addition, we continue to focus on reducing our leverage ratio and we'll use some of our cash balances to repay part of the billion dollars of debt that matures in the first half of 2023 and reposition our balance sheet for the future. On to 2022 guidance. Our new ranges are shown on slide 8 and you can see the outlook has improved from last quarter based on strong performance across the company. The revised guidance includes two months of contribution from the Special Mission business acquisition as well. We now expect 2022 revenues between $14.2 billion and $14.4 billion. So we've added $300 million to the bottom of the prior range and $100 million to the top end, even after absorbing an adverse impact of foreign exchange rates of about $70 million. We're reaffirming our adjusted EBITDA margin guidance of 10.3% to 10.5%. We still have work to do to get back in the margin range for the year, but I'm proud of how the entire company has responded to the margin pressures that we spoke of on the last call. For example, we decreased indirect spending and improved direct labor utilization across all three segments. We're also taking a look at accelerating real estate reductions to drive out additional cost, which will improve our competitiveness and our margins going forward. We'll have more to report on that front on the Q4 call. We're now guiding non-GAAP diluted earnings per share between $6.20 and $6.40. So we've taken $0.10 off the top and bottom of the prior ranges. As I touched on earlier, our effective tax rate for the year is going to be a full point higher than we previously expected, which creates a $0.08 headwind to EPS. Compared to last quarter, our confidence around operating performance has improved. Finally, we're keeping cash flow from operations guidance at $1 billion or greater. Obviously, we had a tremendous performance in Q3, which puts us on track for another strong cash year. We continue to monitor the potential for Congress to act on the tax research cost capitalization rules. With no change in law, the cost capitalization provision amounts to a negative impact to operating cash flow of about $150 million annually. We haven't made any federal tax payments related to the amortization of resource costs this year, and do not plan to, although we will continue to reevaluate as conditions change. Barring a legislative fix, we expect to pay this $150 million in early January of 2023 and then make normal quarterly tax payments inclusive of this impact thereafter. With that, I'll turn the call over to Rob, so we can take some questions. Oh, I'm sorry, Maria. Maria, we're ready to take some questions.

Our first question is from Gavin Parsons with Goldman Sachs.

Roger, you mentioned you don't expect staffing to significantly constrain your 2023 plan. Could you give us an early look at what that plan is in terms of revenue, margins, and maybe cash flow?

We don't guide to 2023 until the end of the year. And so, we're not going to put out any numbers. What we will tell you, though, is that if you go back to our Investor Day and we put some longer-term goals on Investor Day, and we're still confident with the numbers we provided you. I think it was October a year ago. But we're still very excited about what's going on in our space, and we had a great quarter, and we expect 2023 to be strong.

Maybe in terms of defense, you guys have talked a lot about investments you're making there. I wonder if you could tell us a little bit more about that and the expected payback period, that would be great.

Well, maybe I'll start and then Chris can come back in. We, especially in our mission and operations area, find customers who want to accelerate capability and look to the contractor base to make investments to get them capability into theater faster. The army has some airborne programs. In fact, I think our RFP just came out a week ago and we made some investments ahead of that program. We hope to get a decision, which will be next year, and actually start the program next year. When we make an investment like that, it's usually on a pretty short string. And it's very consistent with the airborne work that we already do, and those margins tend to be above our corporate average.

Yeah, that's right. And, Gavin, just add to that, Roger talked about the great win our space team had on the Tranche 1 Tracking Layer. And that's an example of where we've made some investments to ensure we could acquire the appropriate long lead items. Everybody's talking about supply chain constraints. We've been monitoring that to make sure we got out ahead of the materials needed to successfully win that contract as one example and then to continue to invest in our capability in clean rooms, engineering talent, etc. So those are a few examples. The Dynetics, if you're able to make it down to the trip that Roger talked about, that'll give you a firsthand view of some of the areas where we've clearly made some investments in our facilities, team, and capabilities.

Our next question comes from Robert Spingarn with Melius Research.

Roger, when we talk to investors new to Leidos, we often highlight your diverse segments and end markets. In that vein, I wanted to ask a longer-term question as you head into next year and beyond, where you see the sales momentum among the segments based on market interest in your products and services. So, essentially, what I mean is that, obviously, we're hopefully exiting the pandemic and rethinking how we handle a major medical crisis. You're in the health business. We're in the midst of a major infrastructure build here in the US and here in the Civil business. And, of course, we have a rising defense budget and a war in Europe. So how do you think long term about relative growth for each of the segments?

Of course, what we have been saying for years is we have been portfolio shaping and positioning the company both in Health, Civil and Defense, to be in the swim lanes that are moving faster. And so, just as I reflect on all three of those, of course, our Health business continues to have really, really strong momentum. We're almost through the COVID catchup and back to normal growth levels. But we see continued growth in our Health business really driven by CMS, Social Security, and what's going on in DHA, and it's just been a great performer for us. In Civil, we've talked now for quarters about the resurgence in air travel. And we're seeing strong resurgence certainly in the US, as I think all of us can attest. And we're finally starting to see the revenue passenger kilometers pick up internationally. And our SCS team has had probably more meetings with customers in the last quarter than they did all of last year. So we're traveling again. And that bodes well for increased orders, which will lead to increased sales in our global security business. And then Defense, which we actually – if you think about a year ago – thought was probably going to be our lower growth business. But as we've all come to learn, the world is a very complicated place and it continues to be very, very complicated. And I think those issues require that both the US and our allies continue to invest, maybe more than they would otherwise like to in the defense of the nation. Our Defense business has really held up well. And we don't see anything on the horizon that changes our view of that future. I think it really speaks to some of the decisions we made to shape the portfolio and emphasize on the parts of the business that we did. I'll highlight one other thing. It's a smaller business for us and we don't often talk about it. But within the Civil group, we have a commercial energy business. That has just been going great. We do a lot of engineering for investor-owned utilities and energy savings programs for large production facilities. And that business has been growing in double digits. It's interesting that utilities are connected to 5G because you put 5G on towers and you need engineering for that. And that business has turned out to be a huge growth engine for us as well.

Rob, I think Roger covered the landscape pretty well. I would say that, in the near term, again, our Health business, very proud of that business and the team and we spoke about the SSA. This is a hard-fought battle to make sure that we ultimately prevail through the protests. Feel confident. That'll be a growth catalyst for us in 2023. We're quite sure. The RHRP program that we've been talking about for years, finally, we're up and running on that. So really feel like the Health business has room to grow in the near term. And then, the Dynetics business is really 2024 and beyond when you've got these force protection programs, you've got space, you've got things that can really ramp up into significant program quantities. We're very excited about that.

So, Chris, on that last part, you talked about up to 2024. But when I think about five years from now, for example, if Dynetics is growing faster than the rest of the company, do you see the overall portfolio, the three segments, the same relative sizes in that long-term timeframe, five years out?

No, I would say that…

Defense is the biggest piece by double.

Yeah, if you start to get into the back half of the 20s, if things play out the way we hope to, I think Dynetics has more opportunities with the defense hardware side to really grow those into substantial programs. But don't forget, we've got the DES program too ramping up on the digital modernization side. So that should be a big catalyst for us in defense as well. So probably, back half of the year, I can see that Defense segment accelerating growth beyond what we're seeing in Health and Civil, but I wouldn't count them out.

Rob, a point I would make as you think about the coming five years from now, the Health is primarily a kind of a people services driven business and I think it will continue to grow well and we'll provide health managed services to active military and veterans and others. But five years from now, some of the programs that we've been talking about, will be in significant production. That will help to look change the complexion of the company a little bit, so that we have 15% or 20% of month-over-month production programs generating higher margin than our average. What we're going through now in 2022 and 2023 is the development of the programs in enduring fires, the high energy laser, the Common-Hypersonic Guide Body, which is just ramping up, and the stuff we're doing on Tranche 1. By the way, there is a Tranche 2 and a Tranche 3. So if you think about what we will look like five years from now, we will have the base business that we've always had and we will add to it, kind of above that base some significant production programs. So we're really excited about the company five years from now.

Our next question comes from Cai von Rumohr with Cowen.

This is Spencer Breitzke on for Cai. Can you talk about if you've seen a pickup in award activities since the Pentagon occupancy limit was lifted in September?

I don't know, Spencer, that we've seen a noticeable difference before or after, quite honestly. That wasn't really a constraint that we'd seen. I think the Pentagon activity generally has been as expected, the bookings. As Roger mentioned, we did see a number of RFPs dropped in our Defense business here over the course of October. So that's been very active in our proposal pits very recently. So that's exciting to see. But the Pentagon volume, I wouldn't say we noticed a big impact pre or post.

A comment I would make is Bill LaPlante finally was confirmed by the Senate and put in as the acquisition exec in the Pentagon. And I would say since he's taken office, we've seen sort of upbeat in activity. Bill's been very accessible to industry. There have been a couple of tri-service meetings with Bill. And he's trying to, I think, accelerate the RFPs and to get outlays where they need to be. I think that's a real positive sign. I would look more towards that than I would the occupancy limit on the Pentagon. But I will confirm whether it's delivered on the Pentagon or not, I think we've probably been in the Pentagon more in the last quarter than we were in the first half of the year. So I think it all bodes well that will increase the activity and we'll get some of these procurements under contract.

Our next question comes from Matthew Akers with Wells Fargo.

This is Eric Yan on for Matt. Just on CR, could you talk a little bit about the environment we're in today compared to last year? Just what kind of impact have you seen from the CR so far? Also, if you think it'll get extended again into next year?

Yeah. Especially if we compare it to last year – this time last year, I guess I was optimistic that we'd get a bill before the end of the year. And as we recount what happened last year, it almost took the whole first quarter to finally get a bill. That did have an impact. It just caused everything to slow because you're captive to prior-year level. I'm more optimistic this year. I can't predict the future. None of us can, but when we talk to members of Congress, the senior senator from the State of Alabama, they all seem committed to getting it done in the lame duck period after the election. I have more calm pretense that we'll get an omnibus before the end of the year, but no one can predict, lots of issues. I think we're all reading the newspaper about the election and how things will go. But I feel better today than I did a year ago that we're going to get an omnibus and we'll avoid the extended CR that we had last year.

Our next question comes from Peter Arment with Baird.

Peter, maybe you could just update us on how you're dealing with labor inflation just regarding any salary adjustments and how that kind of flows through and impacts the top line, how should we be thinking about that? Well, definitely. And certainly, something we've spent a lot of time on throughout the year and even most recently as a leadership team. So I think what we've been doing is, obviously, our merit budget pool has been increasing and we've seen that consistently over the course of the past two to three years and expect it'll tick up again as we're looking ahead to 2023. In the past, that was a sub 3% kind of annual pool and then we'd have some one-off increases over the course of the year. I think what we're seeing now is above – mid 3s to 4, or higher in certain cases. And so, that will roll through the top line as a tailwind on the cost reimbursable programs, which I'm sure you're aware are in the order of 50% of the portfolio. So that's goodness there on the top line contributor for growth. The balancing act is managing that on the fixed-price and T&M programs. And we’ve been successful there. I would say that managing margins this quarter at 10.3% could have been better. But we're looking ahead to a strong Q4. So we're very thoughtful on building our pricing up and passing those inflationary cost pressures along to our customers where we can. Certainly, it'll be priced in as we put together next year's forward pricing rates. But it's absolutely something we're spending a lot of time on as a management team and being thoughtful, especially for the areas of talent that are in the highest demand.

And just as a follow-up, Roger, can you maybe just update us on the aviation screening business. I know that you kind of put it out there that this was still going to be a challenge in 2024. But just any kind of greenshoots you might be seeing there. Thanks.

I see if I can do this quickly. And we've always described the US business as sort of an RFP, get certified, compete for the business. And it's funded really through authorizations and appropriations. That business continues to go well. There's opportunities to insert new technology, what we call CT or computer tomography at the checkpoint for carry-on. We're in the process of getting our equipment certified. We continue to see success domestically or in the US, along with our competitors. So that business is great. What will really drive growth in that business is the return of the international business, and the international business tends to be funded by ticket surcharges. So it's more related to travel volume than it is in the US where it's essentially funded by the federal government. And it's a lag. So the tickets, traffic has to come back, the ticket volume has to go up. The airport authorities, every airport has a different governance structure, they have to be confident that the volume is there. And then they start to engage with the contractor base, they put out RFPs, we go and talk, we do demos, right. Then it takes literally months or a year or two before there's acquisition, you get certified, you get an award, you build the equipment, you deliver it. So, unfortunately, there's a long timeline to this recovery. But the good news is, at the front end, the RFP activity, the demos, the requests that we have for specifications and the like is up significantly year-over-year. Our team is literally flying all over the world, talking to airport owners and operators about what's available. I'll make another point. We've done this before. During the period, kind of the COVID period, we couldn't use that as an opportunity to up our investment in technology and our product. We wanted to make sure that we had state-of-the-art detection equipment. There are a variety of new substances that airports want to detect, fentanyl being one of them. That required us to tweak our algorithms. There are some other reasons why we tweaked algorithms in the US. But we took the time, right, when maybe production wasn't where we wanted it to be. We took our team and used it to invest in technology to make sure that our products were worldwide competitive. Now, we're benefiting from that, as we are at the leading edge with competition on what we have to offer. Customers realize that and they've asked us to come and talk to them. So we're excited about that.

Especially in the European market, Peter, I'd say that's probably the area we're seeing the most receptiveness. We've had the most visits; there's probably some things that we're more optimistic on there. Hopefully, Asia will follow. But that's probably further behind.

Yeah, I think everyone knows that China is still essentially shut down for COVID and that does dampen travel in the Pacific region. But Chris is right, we've had a lot of trips to Europe.

Our next question is from Colin Canfield with Barclays.

Certainly back on the defense production and airport recovery comments, can you just maybe talk us through the margin bridge from here to 2024's Investor Day target of over 10.5%? Then maybe discuss which programs that you guys are developing under fixed price and how you think about kind of that cash risk versus getting to production?

Colin, I'll start and Roger can pile on. So, certainly, the margin bridge, and as Roger was asked earlier, we're not going to paint a detailed 2023 picture at this point in time. But the good news is, when you look at how this quarter played out, I think that's indicative of a great jumping off point. Health kind of came back to where we expected to be more on a normalized basis. We'll have some up quarters and down quarters, but mid-teens was kind of the baseline and to give us a platform to potentially expand from there. Civil showed what it's capable of with a modest increase in volumes, security products and good management. I'd say the defense side of the business is where we have some more opportunities to increase margins. Balancing all that out, I'd say, looking ahead to 2023, coupled with the inflationary discussion earlier, we'll put together a plan that keeps us in the 10s and where that falls out. More work to be done. But I like the portfolio. Definitely, when we get to 2024 and we've gotten more production-oriented outputs bouncing back in SES, that's when we feel more bullish on the 10.5% plus margin target longer term. So I think we're in a good place to bridge that. I don't know if it'll be an up year or flat year, but more to come on that when we give you the 2023 guidance.

I'll just add a sentence or two, kind of footstooling what Chris discussed. Really two ways we drive margin: Performance on the existing contracts and then changing the mix, so that we have programs that on their face have higher revenue opportunity. We have always focused on performance, and that's your write-ups versus write-downs and control of indirect costs and overhead. We're a very lean company. We have less than 100 senior executives in the company. We run a $15 billion, $14 billion company with that, and we continue to focus on that. In our success, we are not adding to corporate office overhead and indirect costs. Then on mix, and that's been our story now for years, is that we do have in our portfolio some businesses where we operate in Antarctica, we do large M&O. And those tend to be below the corporate average. Over time, those were important programs, important programs for the nation, but we want to complement those with programs that have higher margin potential. We talked about production programs earlier. Even in some of our digital transformation programs, if we can get special project work, if we can do enhancements, we can drive those to the higher margin. If we do all of that, the 10.5% is achievable.

It looks like the DoD put out a strategic plan on Friday. It seems like the plan suggested that we get to 100% MHS GENESIS rollout by 2024. So, if you can just maybe update us on the revenue cadence around that program and kind of how that multi-year step-down interacts with your Health margins.

Colin, again, I think the team has done an excellent job. GENESIS has been a growth driver for us this year. We certainly are pivoting into a point where it's going to taper down a bit, and we're approximately two-thirds deployed through the program at this point in time. So, 2023 will continue on that cadence. What I will say is, certainly, the customer, and Roger can elaborate on this, there's been a lot of discussion, getting the base deployment, but then enhancing the capability of the software suite that we've got available to the customer. A lot of discussion and opportunity and growth that we'll see coming on the back of that, that takes full advantage of what the capabilities are. So, a little early to paint the picture on how much of a step down we'll see as the deployments moderate. But we're very cognizant of that. The Health team has been working hard to find opportunities to offset that.

We continued our deployments through Hurricane Ian. Really on schedule to finish the program, frankly, on cost or under cost and on schedule. The DHMSM program is probably below the average in the Health group. So if you kind of understand the portfolio, it's a very solid program. We're excited about the performance. But there are just the way that portfolio shapes and the nature of the programs that as it tails down and we replace it with other work, frankly, there might even be some opportunities for margin improvement. But the volume is definitely going to come down. We're trying to get to a position where we're doing the operations and maintenance of the system at all the military treatment facilities. But as we've said, I am sure you've followed the program from the beginning, you do get to the point where you've installed the GENESIS software and all the military treatment facilities and the program takes a different shape.

Our next question is with Bert Subin with Stifel.

Maybe staying on the Health side of things, the PACT Act should result in an uptick in the VA backlog as just veterans start applying for those benefits and compensation. But, Chris, you seem to note during your prepared remarks that you aren't seeing that yet. How should we think about that bill impacting both 4Q sales and then into 2023? Is that something that could get Health back to year-over-year growth?

Well, definitely. Part of what we're not seeing is that the VA didn't necessarily set up a way to track that explicitly just yet. So the team is working to make sure we understand what's coming through as the PACT Act cases versus otherwise. But I think the main point is, this is ahead of us. Right? And, yes, it could be a contributor to the fourth quarter, that would be something, if it were to happen, could be one of the catalysts to push us up in the margin range as an example. So that's why there's a range there. But certainly, for 2023, we're bullish on how that plays out. We’ve seen good overall referral volume. We were navigating throughout the year this recompete and reallocation of some of our other work to multiple competitors. But for the most part, that's settled out, maybe there's a little bit more of that to go. But I certainly look at the PACT Act case volume to be one of the areas that can drive growth for us in 2023.

Just on your comments there regarding the margin and EPS range. The narrowed guidance that you guys have implies a pretty wide range of potential outcomes for 4Q, I think, from anywhere from $1.44 to $1.64 in earnings, which would be at the midpoint below what you've seen sort of each quarter this year. Just curious what's driving that expectation? And if you guys were to end up closer to that low end, what do you think would have driven that?

Bert, so a couple of things going on there. Obviously, we'll still see interest rates have been trending up, right? That'll be a little bit of a headwind as we look at the fourth quarter on the below-the-line item. Diluted share count, we're at 138 million, rounding down. There's a scenario where it could pop to $139 million and round up. So, that's kind of in play there. And we talked about the tax rate, right? So, taxes were a driver, the tax rate being higher than we expected at the end of the year. The team is working hard, as they always do, to minimize the tax expense. But I'd say it's more of the below-the-line items that are kind of in play there. I think operationally, we feel solid about the trajectory of the business.

And just a clarification question, Roger, for you, if I could quickly. You noted some positive commentary on SG&A. Are you sticking with sort of the 2024 full recovery timeline?

Yeah. Yeah. We're expecting 2024 to be at or above pre-COVID levels.

Our next question is from Ellen Page with Jefferies.

I understand that you don't want to give 2023 guidance. But are there any major program drivers beyond the SDES and RHRP to think about? And we always hear about your successes, but are there any losses to be aware of?

Those are the bigger ones. Obviously, the SSA, RHRP, we just talked a little about the PACT Act on the disability case volume and where that can play out. Aegis will have a full year of volume. So that's great. And you mentioned DES as well, right? So those are some of the ones that are kind of in the bag that will be growth catalysts. It's not a recent loss, but the NGA items, UFS contract, for example, we talked about that at the beginning of the year as a loss. We continue to execute on that for half the year through the third quarter. That'll fall out of the portfolio. So that's one of the headwinds that we'll have. But more recently, our recompete win rate has been quite strong. So, feel good about that. So, I can't think of another material downer that we'd have to overcome heading into 2023.

Ellen, what's been great about the journey at Leidos is losing a $1 billion program when we were 5 or 10 years ago was really, really material for us. Now, we're bidding probably north of $50 billion worth of stuff in a year. If we were to lose a $1 billion program – and, clearly, we don't win everything, and so there are programs like that that we have not won. Usually, new business and takeaways, not a recompete. It tends not to have a significant impact. All companies do this. Sometimes we stretched a bid on something that's maybe a little bit outside the strike zone, and we lose those, but it helps to build a relationship with the customer. Then maybe when we bid the next program, we win those. Like all companies, we do lose programs. Not every week, but often. But we win a lot more than we lose, which is what we're trying to do. As Chris said, we have a lot of work to do between now and the end of the year. It's amazing how many RFPs have dropped and how busy our team is, frankly, across all five of our business groups and three of our reporting segments and writing proposals over the two holidays, which tends to be the way things work in our industry.

Just on NGEN, profitability was a little lower in the first half. How do we think about revenue and profitability on that program into Q4 and beyond?

I think that's one that I would say the best days are ahead of it as far as profitability goes, quite honestly. Revenue has settled into a nice range, and the team's done a great job, staffing levels are robust. Our team, DJ, our program manager, Steve Hall, our ops manager, have done an excellent job preparing that program for success. I still would say, our expectations, our margins will continue to tick up. I don't think you should expect significant movements, but it should be a nice tailwind for us as we look ahead to 2023 and beyond.

Our next question is from Mariana Perez Mora with Bank of America.

Can you talk about the acquisition clause, what's your appetite to increase international and/or NATO exposure?

International. Mariana, I would say, well, obviously, Roger talked about Cobham extensively, very excited about that one. You know we've got a large presence in Australia just like we do in the UK. So certainly those would be areas that we're quite comfortable adding more capability to. And then, internationally, NATO has been around customer of ours historically. We've done some excellent work for them, some challenging programs, and some very successful programs. But I don't think you'll see a scattershot of other international beachheads. I think we'll be very selective where we have kind of a major muscle movement. Obviously, our SES business does a lot of work internationally. So, that's one that if there's areas to complement their capabilities from a service delivery perspective, we'll look to do that. But right now, it's probably playing to our strengths. I would say our business in Australia and the UK is the top priorities.

Mariana, we tend to go where the US goes. The Five Eyes countries, the NATO aligned countries, and then we tend to go where the world is complicated. Right now, Europe and the Pacific Rim are places that we see growth. So, we're excited about that. Chris mentioned, I think we sell equipment through the SES business maybe to 125 different countries. Not all of that is direct; some of that is through manufacturers' reps, but we have people probably in 40, maybe 45 different countries supporting some of the SES products at commercial airports.

We've been talking about M&A for quite some time. And first the footstool. We don't feel compelled to do a big M&A. We like the portfolio. We like the size, the scope, and scale of the business. It's really opportunistic and places where we can either add a new capability that complements an existing line of business, or we get access to a new customer. The Cobham acquisition is really an example of a capability that we're very comfortable with. We actually fly the same type of aircraft, Challenger 650s and Dash 8s. So, really familiar with the hardware, but it allowed us to extend to a new customer in Australia that's really, really important to the country. Australia has literally thousands of miles of coastline. It's really important that those are surveyed and that they provide search and rescue services. We saw that in combination with our existing footprint in Australia, to extend our business and to access a new customer base that we hadn't accessed before. So it's a perfect example of what we would look for. I'll just put stop again. We're not in an aggressive posture on M&A. I think we're going to be opportunistic, as we go forward and execute on our book of business and deploy our cash in a way that creates value for our shareholders.

Our next question is from Tobey Sommer with Truist Securities.

From a product standpoint and solution standpoint, sort of the higher margin areas of the business, where are you from a mix shift perspective, sort of where the current portfolio is versus maybe what you aspire to over time? And do you have any visibility to that improving or increasing into next year? You mentioned a LEO satellite, which is why I asked?

Toby, we don't put out hard numbers. I would tell you from a solution standpoint, we're pretty comfortable with where we have moved and the evaluated work that we do, the special project work we do on some of our contracts. To provide a solution to a customer, we've really worked hard to position the business in that way. From the actual hardware component – by the way, we love to make hardware that is part of the bigger solution where those things go hand in glove. But we've been working through program wins and through M&A to add a slight bit more hardware component to our offering. By the way, it tends to have very sticky IP. If you've got a manufacturing facility, you tend to hold on to the program. They tend to be longer-lived as programs go. You have 5-year production runs, you have 10-year production runs. Although we have some things that are in production, our hope is to add four or five products to our production portfolio. As we said at the beginning, five years from now, to have a more significant part of our portfolio is actually connected to some hardware.

To follow-up on a prior question about sort of M&A, I know you've put out some stuff, but from a market perspective, with higher rates and PE maybe not being able to pay the same kind of multiples they otherwise would, lower leverage, higher interest, does that over the next, I don't know, so many quarters provide a better opportunity for strategic buyers, such as yourselves with the financial flexibility to maybe compete even more successfully on a go-forward basis for acquisitions than you might have been able to in recent years with low interest rates?

Toby, it's a good theory. There is a strong basis in the points that you make. First, I'd point out, PE is still very strong in our markets. Without going through some of the specific firms, one just did a $10 billion capital raise, and there seems to be a lot of money available to private equity. We don't see them leaving the market. Interest rates drive up the cost of capital for everybody. It does change the business case. But it also would change the business case for us. Do I think strategics kind of come back with a little bit more balance sheet power and then play in the market? It could happen. What we try to do is not get tied up in thinking if it's a good interest rate or a bad interest rate. We really try to look at the fundamental, strategic fit of the business and then see if we can get it at a price that closes on our business case. We've used that approach in everything that we bought. That’s really how we do M&A going forward. Interest rates come and go, PE can come and go, and we just need to stay close to our strategy and our knitting and buy those things that make sense for us.

Maria, it looks like we're just at the top of the hour. So I think we have time for just one more question.

Our last question is Ken Herbert from RBC Capital Markets.

Roger, I just wanted to ask you. You've got, obviously, a number of opportunities on the hardware side. And if I think about your defense portfolio and you've alluded to an anticipated step up in 2024 in this business, what should we focus on? What are the key milestones in 2023 as you look at that portfolio, either in terms of contract milestones, down selects? How should we think about tracking this through 2023 and what could you highlight as sort of the key watch items?

Ken, great kind of a provocative question. By the way, the good news is lots. No single program, no single downselect drives the business. We've got to get wide field of view Tranche 0 up into space, we're going to get Tranche 1 up into space, we've got to transition our enduring fires, both the enduring, which is the missile and high energy laser, we need to get those in to test. We have some things on the weapons side, those need to get into test. On the airborne, we need to win the next airborne competitive program with the Army for their enhanced ISR program, which is a Bombardier 6500 class aircraft. We just go around the portfolio and it's a lot of, I won't call it, singles and doubles, but it’s World Series season. Those are kind of singles and doubles; there is no big home run out there that we need to execute the strategy. Just kind of look at the press releases, and we went into programs, so they have hardware content. Are we successful in getting these things fielded, getting things in orbit? Our MUUV program that I talked about, so we now are in development. We need to get PDR, CDR into production. We need to start building UUVs. They just continue in that vein.

I feel like we're a shill for the Dynetics business, but the team will certainly talk in more detail at the end of November and December 1 on what some of those milestones look like. Roger has just hit on it. We're excited that we have more than a handful to focus on, but we've got the right team executing against that. There are some things where hopefully there will be some additional contractual orders you'll see out of SES and maybe a low-rate production order out of Dynetics. But, again, that site visit will give you an opportunity to dig deeper there.

If I could, just one quick follow-up. You're, obviously, well positioned in a lot of growing markets, relatively early stage in some of these, how much is technology maturation a risk around just the government's ability to move forward on some of these to the scale in which we'd like to see?

By the way, come to Huntsville, and we'll talk about technology, we'll talk about the technologies in the different products. First of all, we want to have programs across the lifecycle of technology. We're going to be doing work with DARPA, low level TRL kind of programs. When we're starting to talk about production, then those are higher TRL programs. If I think about, say, if the enduring fires programs, the technology risk is essentially behind us. So, we need to apply the technology, we need to make it work, we need to connect it to the fire control system, we need to take it out on the ranges and shoot it and demonstrate it. But from an invention standpoint, we do that kind of work under, we call it, 6263 kind of early stage programs with customers like the Office of Naval Research and AFRL and DARPA. Those are take risk, invest, fail fast kind of programs, and we love having those. Our people love working on those, but the ones that are significant in our financials going forward, we've gotten through CDR, PDR, we bought down the technical risk. You'll be impressed with the level of technology we have in those programs and how mature that technology is, if you can make it to Huntsville.

Okay. There are no further questions at this time. I would now like to turn the floor back over to Mr. Davis for closing comments.

Maria, I want to thank you for your assistance on this morning's call. Thank you everyone for joining us this morning and your interest in Leidos. We look forward to updating you again soon. Have a great day.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.