Greetings. Welcome to the Leidos Fourth Quarter 2022 Earnings Call. At this time, all participants will be in listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I’ll turn the conference over to Stuart Davis, from Investor Relations. Mr. Davis, you may now begin.

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our fourth quarter and fiscal year 2022 earnings conference call. Joining me today are Roger Krone, our Chairman and CEO, and Chris Cage, our Chief Financial Officer. Today's call is being webcast on the Investor Relations portion of our website, where you'll also find the earnings release and supplemental financial presentation slides that we're using today. Turning to Slide 2 of the presentation. Today's discussion contains forward-looking statements based on the environment as we currently see it and, as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. Finally, as shown on Slide 3, we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is included in today's press release and presentation slides. With that, let me 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. Happy Valentine's Day. The fourth quarter marked a strong finish to a banner year for Leidos with record revenue and non-GAAP diluted EPS driving us to the top end of our revenue guidance range and beyond our EPS guidance range for the year. Our performance validated that our diversified and resilient portfolio and our investments in technology and innovation are positioning us for growth in key customer missions including digital modernization, cyber, hypersonics, and force protection. Each and every day, our 45,000 people are helping our customers execute on important missions and meet the world's most complex challenges. Against the challenging backdrop in 2022, we delivered on our financial commitments, allocated capital to deliver value for our shareholders, won multiple franchise programs that position us for future growth and significantly grew our talent base. So let me provide more detail on each of these points. Number one, our strong financial performance in the fourth quarter enabled us to deliver on our financial commitments. Record revenue of $3.7 billion for the quarter and $14.4 billion for the year, we’re up 6% and 5% respectively. Adjusted EBITDA margin of 10.7% in the quarter was up 40 basis points year-over-year, which helped drive adjusted non-GAAP diluted EPS to a record $1.83, which represents growth of 17%. For the year, adjusted EBITDA margin of 10.4% helped lead to non-GAAP diluted EPS of $6.60, which was well above our guidance. We generated $105 million of cash flow from operations in the quarter and free cash flow of $52 million. For the year, that translates to nearly $1 billion of cash flow from operations and $857 million in free cash flow, which were right at guided levels. These results came despite multiple headwinds, most notably a protracted continuing resolution to start the year, inflation, supply chain disruptions, and labor constraints. Even at industry-leading scale, we’re nimble enough to pivot as needed. And I'm proud of how well the team pulled together and weathered these challenges. Number two, in 2022, we allocated capital to deliver value for our shareholders. Over the year, capital deployment was heavily weighted towards returning to shareholders while still layering in strategic acquisition of the Australian airborne business and investing to grow our core business through capital expenditures and internal R&D. With our asset-light model, CapEx was just under 1% of revenues with large investments in airborne ISR and Dynetics, and we're seeing those investments pay off in additional aircraft performing valuable missions and key wins in hypersonics. This takes me to number three, business development. This year, we won franchise programs in each segment that position us for growth. Programs like DES in Defense, Social Security Administration IT in Health, and AEGIS in Civil contributed to performance in 2022 and have built the foundation for 2023 and beyond. They demonstrate our ability to take away work and target brand-new opportunities. In the fourth quarter, which is typically the weakest in our industry, we booked $3.7 billion of net awards for our book-to-bill ratio of 1.0. For the year, our book-to-bill ratio was 1.1. Total backlog at the end of the quarter stood at $35.8 billion, of which a record $8.4 billion was funded. Total backlog is up 4% and funded backlog is up 13% year-over-year. After a relatively slow start to the year across the industry, contract activity is improving. Most importantly, our submit volume picked up dramatically in the fourth quarter with $23 billion in submits, of which 92% was for new business. Taken together, the two Social Security Administration IT task orders that we spoke of last call were the largest award in the quarter. GAO dismissed the competitor's protest earlier than expected, and that program has fully ramped. We also won more than $0.5 billion in hypersonics awards, including Mayhem, our first major contract on the air-breathing side and wide field of view Tranche 1, which is the backbone of the nation's hypersonics defense capability. We're pleased that so many of you were able to join us in Huntsville last December to get a clear picture of the opportunities that we see at Dynetics. Our independent research and development investments were critical to procuring these awards just as they were for our landmark wins in digital modernization. In 2022, we invested $116 million in IR&D and IRAD has grown at a compound annual rate of 23% over the last five years. We continually invest to develop proprietary tools and unique processes to drive competitive advantage. We've already deployed workflow transformations using the latest generation of AI based on large language models and we're at the leading edge of combining artificial intelligence and cyber to enable our customers to achieve security levels that are beyond compliance. Speaking of cyber, earlier this month, we announced the latest version of our Zero Trust Readiness Level tools suite that simplifies Zero Trust adoption for government organizations, consolidating a six month to nine month planning process to less than 60 days. We drive digital innovations by working tightly with our product partners. For example, we've partnered with Intel Corp. to demonstrate confidential computing through a hardware-based independently attested trusted execution environment. And just last month, we were recognized as the 2023 ServiceNow America's Premier Partner of the Year. Number four, we significantly grew our talent base. We hired more than 2,400 people in the fourth quarter and more than 11,000 in 2022. Headcount was up 6% for the year and attrition rates continue to subside. We've seen great synergy between our people engagement and technology investment initiatives. Employees in our technical upskilling programs have significantly higher retention, and we more than doubled participation in 2022 compared to 2021. Our technical upskilling programs are aligned with our technology strategy, and broad participation is enabling us to enhance our competitive position and deepen our culture of innovation. If you want to build your technical skills over a fulfilling career, Leidos is a great place to work. In 2022, we offered courses in artificial intelligence and machine learning, software, cyber, cloud, and digital engineering. In 2023, we're expanding with new offerings in cyber operations, secure rapid software development, and specialized learning paths in AI and ML. We also take learning and engagement beyond the classroom. Two weeks from now, we will launch our seventh annual AI Palooza challenge, where employees around the company will engage with some of the newest AI and ML techniques in a creative and collaborative competition. Perpetual learning is part of our culture, and we make it fun. Before turning it over to Chris, I'll touch on the current budget environment. Demand trends are very positive for our business. Late last year, Congress overwhelmingly passed, and the President signed, the Omnibus Appropriations bill, funding the government through September. Budgets across the board saw healthy increases, including defense spending, which was up about 10%. The budget addresses the critical challenges we're facing as a nation, including national security concerns arising from China and Russia, and Leidos is well-positioned to respond. Amidst a highly partisan backdrop, President Biden's calls in the State of Union address to support Ukraine, protect our country, and modernize our military to safeguard stability and deter aggression received strong bipartisan support. That said, we're anticipating a series of noisy debates over the coming months around the debt ceiling and the 2024 appropriations given the razor-thin majorities and the deep divisions in Congress. As a matter of prudence, we are preparing contingency plans around a potential government shutdown. But we built our 2023 guidance, assuming a continuing resolution beginning in October and extending through the rest of the year with no government shutdown. We believe this is the most likely outcome. In summary, I'm pleased with the performance and the momentum of the company. In the fourth quarter, we posted record levels of revenue, non-GAAP diluted EPS, and funded backlog, as well as the highest adjusted EBITDA and adjusted EBITDA margin and lowest attrition rate for the year. We anticipate that 2023 will be another good year for Leidos, marked by strong hiring, important new wins, solid growth in revenue, and operating income. With that, I will turn the call over to Chris for more details on our results and our 2023 outlook.

Thanks, Roger, and thanks to everyone for joining us today. Let me echo Roger and express my gratitude to the entire Leidos team for how we executed in 2022. We navigated many challenges throughout the year, including an unexpected adverse arbitration ruling in Q2, to deliver at the top end of our revenue guidance range and above our EPS guidance range for the year, all while delivering for our customers. Turning to Slide 5. Revenues for the quarter were $3.7 billion, up 6% compared to the prior year quarter. For the year, revenues were $14.4 billion, which was up 5% compared to 2021, despite a $107 million headwind from foreign currency movements, primarily from work in the UK and Australia in our Defense Solutions segment. 2022 revenue performance was in line with the targets that we laid out 16 months ago for '22 through '24. Turning to earnings. Adjusted EBITDA was $397 million for the fourth quarter for an adjusted EBITDA margin of 10.7%, our highest margin of the year and above expectations based on higher growth on more profitable programs, better performance on some large programs, and disciplined cost management. 2022 adjusted EBITDA was $1.49 billion for a margin of 10.4%, or right at the midpoint of guidance that we've held all year. Non-GAAP net income was $255 million for the quarter and $919 million for the year, which generated non-GAAP diluted EPS of $1.83 for the quarter and $6.60 for the year. Non-GAAP diluted EPS was up 17% for the quarter and essentially flat for the year as a result of some one-time events that we've talked about in the past. Looking at the key drivers below EBITDA. The non-GAAP effective tax rate for the quarter came in at 20.1%, which was below our expectation and added about $0.09 to EPS. The tax rate benefited from certain international tax credits and limitations, increases in our federal research tax credit, and higher than planned stock compensation deductions. In addition, net interest expense in the quarter increased to $51 million from $46 million in the fourth quarter of 2021. Finally, the weighted average diluted share count for the quarter was 138 million compared to 142 million in the prior year quarter, primarily as a result of the $500 million accelerated share repurchase agreement implemented in the first quarter of fiscal year 2022. Now for an overview of our segment results and key drivers on Slide 6. Defense Solutions revenues in Q4 of $2.07 billion were essentially flat compared to the prior year quarter. 2022 Defense Solutions revenues of $8.24 billion were up 3% for the year. Civil revenues were $938 million in the quarter, up 17% compared to the prior year quarter, and 2022 revenues were $3.46 billion, up 10% compared to 2021. The primary driver for growth in the quarter and the year was the ramp on the NASA AEGIS program. In addition, we had good growth within our commercial energy business, as well as increased security products sales and maintenance. Health revenues were $691 million for the quarter, an increase of 10% compared to the prior year quarter, driven primarily by performance on DHMSM and our new work on SSA IT. Health revenues were $2.69 billion for the year, up 5% over 2021, with the same drivers that I cited for the quarter plus strong performance on the Military and Family Life Counseling program. On the margin front, on Slide 7, Defense Solutions and Civil posted their highest margins in more than a year based on mix and some excellent program performance. For the quarter, Defense Solutions non-GAAP operating margin came in at 8.6%, up 40 basis points compared to the prior year quarter; and Civil came in at 11.2%, up from 10% in the prior year quarter. Defense Solutions non-GAAP operating margin for the year was 8.3%, which was down 30 basis points from 2021, primarily from investments in new program startups. Civil non-GAAP operating margin for the year was 9.2%, down from 10.2% in the prior year, driven by legal matters that we've addressed in prior calls, a $26 million gain in 2021, and a $19 million expense in 2022. Health non-GAAP operating margin for the quarter was 14.3%, consistent with what we've been talking about for some time. Health non-GAAP operating margin for the year finished at 17.1%. Turning now to cash flow and the balance sheet on Slide 8. Operating cash flow for the quarter was $105 million, and free cash flow, which is net of capital expenditures was $52 million. For the year, operating cash flow was just shy of $1 billion, and free cash flow was $857 million for a 94% conversion rate. In the fourth quarter, we completed the acquisition of the Australian airborne business, which provides maritime surveillance operations for the Australian border force and search and rescue response capability for the Australian Maritime Safety Authority. Purchase consideration was approximately $190 million, net of $6 million of cash acquired. During the fiscal year 2022, Leidos returned $741 million to shareholders, including $199 million as part of its regular quarterly cash dividend program and $542 million in share repurchases. As of December 30, 2022, the company had $516 million in cash and cash equivalents and $4.9 billion in debt. Roughly $1 billion of that debt will come due this year, most of it in May. We expect to fully repay the remaining $320 million on the short-term loan originally tied to the Gibbs & Cox acquisition and then rolled over in support of the ASR program. We'll refinance the $500 million of maturing bonds as well as the bank term loan A still tied to LIBOR in an efficient and flexible manner, but interest expense will increase given the current rate environment. As we approach the debt market, we're pleased with the recent upgrade from Moody's to BAA2 credit rating, which signals their confidence in our financial stability and outlook. We're already benefiting from improved terms on our commercial paper borrowing and expect that to carry through on the debt transactions. As we close out the year, we remain committed to a target leverage ratio of 3 times. Our long-term balanced capital deployment strategy remains the same and consists of being appropriately leveraged 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. Onto the forward outlook on Slide 9. For 2023, we expect revenues between $14.7 billion and $15.1 billion, reflecting growth in the range of 2% to 5% over fiscal year 2022. Demand remains strong as our customers execute robust budgets, and we enter 2023 with a number of programs that are ramping, but the procurement process is still protracted. We expect 2023 adjusted EBITDA margin between 10.3% and 10.5%. The midpoint of the margin range is the same as 2022, and the top end is consistent with the target that we laid out at our October 2021 Investor Day. We're committed to long-term margin expansion, and we'll pull multiple levers to offset the impact of inflation and supply chain on our cost structure, as we demonstrated in the back half of 2022. We're closely managing our corporate costs with a special focus on real estate. GAAP net income in the quarter reflected impairment charges of $37 million from exiting and consolidating underutilized lease spaces. Since beginning our journey to optimize our real estate footprint post-COVID, we've exited over 2 million square feet, which is about 25% of our office space. Getting out of that space improves our competitiveness and keeps corporate costs in check. We expect non-GAAP diluted earnings per share for 2023 between $6.40 and $6.80 on the basis of 138 million shares outstanding, which is unchanged from fourth quarter levels. To provide some context around that range, we expect 2023 net interest expense of approximately $225 million and a non-GAAP tax rate between 23% and 24%. These two items amount to an EPS headwind of about $0.20 for the year. Finally, we expect operating cash flow of at least $700 million. This guidance reflects approximately $300 million of additional cash taxes compared to fiscal year 2022, primarily related to the Tax Cuts and Jobs Act of 2017 provision requiring the capitalization and amortization of research and development costs. As we're awaiting potential congressional action, we didn't make any Section 174 related tax payments last year. So we'll need to make payments this year to cover both '22 and '23. We paid the 2022 Section 174 taxes in January, and we expect to pay the 23 taxes in quarterly installments throughout the year. From a free cash flow perspective, we're targeting capital expenditures of approximately 1.5% of revenues based on the timing of some investments in Australian and U.S. airborne surveillance as well as in-sourcing some of the security product supply chain. As is our usual pattern, cash generation will be back-end weighted in 2023, along with the tax and debt payments in Q1 and Q2, this limits the ability to deploy capital for shareholders in the first half of the year. As a result, the EPS guidance range does not account for any repurchases, and we'll update you as we go throughout the year. With that, I'll turn the call over to Rob, so we can take some questions.

Thank you. At this time, we will be conducting question-and-answer session. Thank you. And our first question comes from the line of Robert Spingarn with Melius Research. Please proceed with your question.

Hey. Good morning.

Good morning, Rob.

Good morning, Rob.

Chris, regarding the guidance, could you provide more details on a segment basis about what drives the 2% to 5% growth across the segments and how the margins compare to the 2022 performance on a segment basis?

Well, Rob, you know that we don't guide by segment, but I'll give you a little additional color commentary. First of all, we're planning on growth across all of our segments. And our leaders have signed up to that. We feel good about that. We're seeing strong demand and pipeline and bid opportunities really across all three segments: Defense Solutions, Civil, and Health. On the margin front, we've been communicating this for some time. Health margins were overheated in '20 and '21. Those started to moderate down. You saw that in the fourth quarter that they're coming to a place that we believe is sustainable, and then we can build off of that going forward. So what I would tell you is that's how we see health playing out is in the mid-teens as we've communicated. But we're very focused in the other two segments about continuing to drive margin expansion, Defense Solutions and Civil. So that's generally how we see the year playing out. And hopefully, that gives you enough additional color commentary.

Yeah. And then, Roger, going back to the security products business and the supply chain there, what parts of that might you bring in-house?

Some of the manufacturing. We've used a contract manufacturer for some of the lower-level parts and then final assembly of some of the pieces of equipment. And with the Dynetics organization and the expertise we now have, we're very comfortable with doing more of those operations internally. We have more control. We can manage the supply chain. Frankly, we think we can drive the cost down. And that's been part of our strategy, and we are having the conversations about a manufacturing center of excellence, which I think really is a great part of the evolution of the company. And so we can look at, if you will, larger manufacturing like the provision system, which I'm sure you all go through, and be very confident that we can build that well in-house.

Thanks so much.

Yeah. Thanks, Rob.

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

Good morning, everyone, and thank you.

Good morning.

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

You highlighted all the key players, Sheila. First, I want to commend the SSA team for their exceptional work during the transition, and I couldn't be more pleased with the customer's decision. As we enter the fourth quarter, we are eager to get started, and we anticipate this will significantly contribute to our growth in 2023, which is promising. Regarding RHRP, we are confident it will begin to gain momentum toward the end of the first quarter, with some activity in March, and we expect growth to build from Q2 onward throughout the year. This sets us up for solid growth momentum. Last year's story became a bit complicated as some pre-discharge work went to various competitors, but we also have international projects that we secured and that are ramping up this year. We foresee growth in that area, and we will provide more details in a quarter or two. Lastly, for DHMSM, towards the end of this year, we will need to continue managing the ramp down on the deployment side, but our teams are doing an excellent job expanding the capabilities of the deployed software. We are actively seeking opportunities for further development. I'm not sure, Roger, if you'd like to add anything.

No, not really. Although, Sheila, I'm sure you've heard in the State of the Union address that the President talked about burn pits and making sure that we took care of veterans. And so it has been slow, but solid, and we would expect that momentum to continue throughout the year. That's more likely to affect volume than margin. But we've seen, again, our volume hold up well in our exam business and look forward to another strong year.

Okay. No, that's helpful. And then I wanted to talk about margins as well, defense was solid in the quarter, but I think it was mainly stable that in Q3 and Q4 have seen really good performance there. So what's sort of going on? You mentioned larger programs, but I didn't think you had anything in particular there. So how do we think about civil margins going forward and what's the driver of the better performance in the second half of the year?

Civil has seen some growth in the security products area, with certain quarters showing more volume and others less, but it consistently contributes positively. Our commercial energy business is performing steadily, growing nicely from one quarter to the next and generating higher margins, thanks to the team's excellent efforts. In terms of digital modernization, while AEGIS isn't among our highest-margin programs, it provides a solid foundation. Many employees contribute to this work, which helps manage costs in other areas and enhances profitability for different programs. We are also optimistic about the pipeline of additional digital modernization IT opportunities within that sector. Furthermore, everyone has been focusing on cost management, especially in the latter half of the year, and I want to commend the civil team for their exceptional efforts in identifying sustainable efficiency opportunities within the organization. We appreciate how that performance is evolving.

Sheila, I would add, if I could, because I know you followed us for a long time. What's been great about our civil business is that it's growing. And we have a base of business in that segment that is sort of infrastructure support business. We run Antarctica. We've got the Hanford contract. We do some other work for DOE. And as great that work is, it traditionally does not carry the margin of the rest of the company. And so as Civil grows top line, you see the margin increase because we're adding new business sort of at the margin and the mix is shifting in civil. So the more we grow civil and we hold the infrastructure business constant, the more growth in margin you're going to see. And the team there has done a great job of growing.

Great. Thank you very much.

Yeah.

Thank you.

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

Hey. Good morning.

Good morning.

Roger, following up on an earlier question, if we look at Leidos' portfolio in 2023, we see several factors such as the ongoing recovery in aviation security, noted growth in commercial energy, and the annualization of the SSA task orders. Additionally, there’s the debt. These are just a few items that I believe would contribute to mid-single-digit organic growth. What are the counteracting factors that bring you down to that 2% to 5% range?

You make it sound so easy, Bert, you're right. There are a lot of tailwinds, no doubt about it. But we…

We've always mentioned that the DHMSM program is coming off its peak. I believe it's one of the standout programs for the company, and we're now over halfway through it. As we’ve previously discussed, we will start to slow down. This program has delivered exceptional results for us, positively impacting both our revenue and profits while meeting the schedules for our soldiers. So, this is one of the programs that is tapering down.

I would also point there's a couple of spots in our Intel business. It's been fairly public, the Fox procurement process. And while that has some room to go ahead of it still to see how that fully plays out. That's an area that could put some pressure on revenue growth if it doesn't go our way. And then, we lost a program a year ago, and this is how long things take called items UFS. And so the good news is the Intel leadership team did a great job throughout 2022 to continue to support the customer during transition, but now we're fully rolled off that program. So that's a little bit of a headwind. But by and large, we've had great success on our recompetes. I really love the team's performance there. There are a lot of tailwinds that are known, but we also have seen customer behavior take longer, especially if they're worried about the budget environment transitioning into government fiscal year 2024. So our hope is, we'll build momentum through the year. We'll have some successes, and we'll be able to update you in a positive direction.

Yeah. That's super helpful. Thanks. Maybe one item, Roger, that you had talked about before and I thought I gave some good color from DES. Obviously, that has the ability to be a significant driver on the sales side for the company. And you talked about that as being tens of millions of dollars in '22 and then maybe doubling from that range in '23 and then really starting to ramp by '24, is that still how you're looking at it or how should we think about the range of potential outcomes for that contract this year?

I believe that's a solid approach to developing your model. I met with a customer yesterday, and we had an extensive discussion about the program. Everyone is eager to progress quickly, especially as this involves moving non-combat support organizations to what we refer to as DoD net. However, we are committed to doing it properly and at the right time, as it will result in cost savings and enhance interoperability among the support agencies. It's essential that we avoid creating a negative user experience for those assisting the military. We discussed the possibility of accelerating some of the transformations and transitions, and we are currently exploring that. There is potential for higher outcomes, but we are not making any formal guidance on that yet. We will provide updates each quarter regarding our progress and whether we can increase the ramp. I can assure you that we are very optimistic about 2024 and 2025. As the ramp-up progresses and we execute these conversions, we will see how much more we can achieve than initially described for 2023. Both the customer and we are eager to move quickly, but we understand that rushing can lead to a poor user experience, which we want to avoid.

Thanks.

Yeah.

Thanks, Bert.

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

Yeah. Hey, guys. Good morning. Thanks for the question.

Good morning, Matt.

I wanted to ask about the cash flow guidance for '23. And I think if you back out Section 174, I think it's kind of flattish year-over-year. I think the payroll tax goes away in '23. Is there any other sort of offsets to that or working capital maybe that are preventing that from being higher?

Well, again, Matt, with the growth we've had and the growth that we see ahead of us, there are some modest investments in working capital for a few particular programs. If we're able to win a program like FINS, for example, there's an initial amount of equipment that you have to procure and bring on board to support the customer. So there are a few things like that in our pipeline that we're anticipating. We finished the year at 58 days DSO, and that's good performance. I think there's opportunities to drive that even lower, and we're focused on that as a finance team with our lines of business leaders. So we thought we'd start the year at $700 million. I mean it's not a never a slam dunk, but our focus is to continue to build momentum on the cash side. But nothing out of the ordinary as it relates to working capital investment, but there are a few programs that we are anticipating needing some support as we win them and grow them.

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

First of all, no, we haven't reached that level of planning yet. To quantify the impact, we would need to select a date and determine which programs are essential and which are not, along with strategies for mitigation. What we typically do, though too many times, is work with our contracts organization to review our approximately 3,000 contracts to understand how each would be affected by a government shutdown. Some contracts are straightforward, as they are considered essential and will continue, while others will not be essential. As part of our preparations, we engage with contracting officers regarding programs that may fall in between and explore ways to mitigate the impact of a shutdown. It is important for us to be prepared, and experience shows that when we are well-prepared, the likelihood of needing to implement our plan decreases. However, if discussions between McCarthy and the President lead to a situation where we reach June unprepared, we will have failed in our duty to manage a government shutdown effectively. This process is one we've initiated, and since we've been through this before, we have a well-established plan that we have revisited and refined.

Thank you.

Yeah.

Thanks, Matt.

Next question is from the line of Peter Arment with Baird. Please proceed with your questions.

Yeah. Good morning, Roger, Chris.

Hey. Good morning, Peter.

Maybe you can just update us on how NGEN is doing. I think we are kind of expected to hit kind of a steady state in 2023 in terms of a ramp. What's your thoughts on that?

NGEN? Well, it's pretty much fully ramped. And you're really doing well. We're in full possession of the network, Peter. I know you know the program well, but our first task was to take the custodianship of the Asure Network, okay? So we've done that. Now the challenge is to transform that network to modern technology. And we're in the process of keeping the call center up, maintaining the network, trying to get the quality of service up while we move to the new environment. And there is opportunity, we believe, this year for additional scope through special projects and on-contract growth in task orders. And we are starting to see some of that. I think we have talked in prior calls that was a little slow in coming. But we have talked to the Navy and frankly, I've talked to our program manager, and we're starting to see some of that break free. We see lots of opportunities where technology can add value to the user experience in the Navy. And so we're constantly making suggestions to the customer about things that can be done to improve the network and which would end up in growth for us, but more importantly, would end up in better quality of service for the user. I don't know, Chris, do you want to add?

No. First of all, we have an excellent team managing that program. It's our largest program and we are only a year or 18 months into it, so the best is yet to come. As Roger mentioned, we are clearly pinpointing areas where we can better support the mission and the customer, which could lead to contractual actions and modifications. We are definitely interested in pursuing that, but at a pace that suits the customer. We are optimistic that we will continue to see growth and margin improvement for that program as we move into next year and the year after.

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

Absolutely. And Peter, we're all smiling because we actually do have chat GPT in our environment, and we debated whether we ought to talk about it. It seems such a popular term now, and I guess Microsoft is going to put it under being and really make a super search engine out of it. But I think what everyone needs to understand is those technologies are available to anyone who wants to use them. And I think the benefit goes to those people who capitalize on not only the money we spend internally, but the billions of technology money that's spent outside the company. And so we are very aggressively using things like chat GPT and other modern language AI platforms. And we've deployed robotic process automation in accounting, like in Chris' area. I mean we don't talk much about that. We're certainly doing it for customers. We're using it. I like to analyze images and all the applications that you can imagine. But we're also using it internally in our functions to be able to, if you will, use computers to do what we call the dull, the dirty, and the dangerous, right, and free up the human, whether that be a financial analyst or an accountant or an imagery analyst or even a linguist, right, in our linguistic program do what the human does best, which is to add that cognitive discernment and then let the computers crunch through the gigabytes and petabytes and terabytes of data that we now collect.

Appreciate the details. Thanks, Roger.

Thanks, Peter.

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

Hey. Thanks very much. Good morning, everyone.

Good morning.

I was wondering maybe if you could talk a little bit about the '23 Omnibus and kind of how that's set up your expectations for the growth that should be coming in the Dynetics programs, particularly in the 2024 time frame?

Those are two subjects that are somewhat connected. Let me explain them, and Chris can clarify if I make any errors. Considering the current year and the situation on Capitol Hill, I believe the Omnibus represents the best outcome we can anticipate. My hope and our goal is for McCarthy and the President to find a way to raise the debt ceiling well ahead of the June deadline. The debt primarily covers expenditures from previous years for authorized spending that has already been committed, and we're effectively just funding the government. We are optimistic that this funding will be slightly above 2023 levels. There is always a balancing act between defense and non-defense spending; if defense funding increases, some elected officials will want to raise non-defense budgets by the same amount. This could slightly limit the increase in defense spending, but given this year's robust defense budget, I believe we will be fine. Regarding Dynetics, if you were in Huntsville, you would have seen a lot of production in the low-rate initial stage, where we are building the first production units, which will lead to a significant ramp-up in 2024. We are looking at increasing production from one unit per month to potentially one or two per week. While I won't detail each program, most of the funding is already authorized and appropriated. If we receive an omnibus, the ramp-up we discussed in December is nearly guaranteed since these are fully funded programs. While there are various scenarios to consider involving the debt ceiling, we believe it is highly likely that an omnibus will be passed, possibly including growth and a supplemental for Ukraine, which seems unlikely to decrease. Therefore, we expect our production ramp-ups in 2024 to be fully funded, leading to significant growth for Dynetics, and Chris can elaborate further on this.

Not a lot to add. I mean, Seth, obviously, you can tell from Roger's comments, which were mostly focused towards the future ‘24 we felt really good about how '23 Omnibus came out, and our Leidos affairs team does an excellent job, and we clearly were making sure members understood the importance of some of our key programs. And we like the way we came out. You don't get everything funded at the level that you'd like. But on balance, we thought we came out exceptionally well and well protected with key programs, and that sets us up nicely for this year.

Cool. Excellent. Okay. I’ll leave it there for this morning. Thanks very much.

Thank you.

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

Yes. Hi. Good morning.

Hey. Good morning.

Maybe for Chris or Roger, you did a really nice job sort of sequentially first half to second half in '22 on the margins. And I know you went through a number of items around your physical footprint, some insourcing, maybe some labor savings. But it also sounds like from the guide that in your comments that you're obviously not going to keep all of this. My question would be, how do you view sort of incremental sort of corporate level cost opportunities as you look at the business into '23? And how is the discussion with the customer in terms of how much you're able to keep, what's necessary to be competitive and win share in the marketplace? I mean how do you view these dynamics into '23? And where are the incremental opportunities at the corporate level from the cost side?

Well, Ken, let me get started. Roger might pile on. So first of all, very proud of the team, second half of the year as a team, we really rallied and showed we're capable of on the cost control, margin improvement front. And quite honestly, that was despite the fact that we had some program areas where we could have done better. And so I think that gives us some confidence and momentum going into '23. Now a couple of things to keep in mind. The Health Group overall for the year finished still above 17% on margins. right? So fourth quarter was definitely more in line with what expectations are going forward. But earlier in the year, there was still some stronger performance from caseload and QTC and other things that drove that higher. So that will still moderate down a bit, but we do intend to capture the savings and the margin upside that we've been able to realize in other parts of the business. And we're not done in Defense Solutions and in civil for sure. And as we build our pricing, we have a rigorous process with our competitive intelligence team to kind of keep us in tune with where we need to be on a price to win front. We factor that in making sure that we can remain competitive while still trying to capture some of the margin upside. So the guidance is balanced for next year. And again, there's momentum there. I wouldn't say there's any super low-hanging fruit on the cost reduction side because we do focus on that continuously. But there's still more that we can do, and we're focused on hitting that 10.5% long-term margin target or greater by 2024.

I don’t have much to add, Ken. I want to highlight a couple of points that may not be clear. Taxes and interest are beyond my control, and they represent about a $0.20 challenge to our earnings per share. We’ll do everything we can, and our tax department is exceptional, so we’ll see if we can minimize that impact. Unfortunately, due to rising interest rates and our approach to managing our balance sheet, which involves consistently replacing expiring debt, we face an additional headwind. However, our guiding principle is that if we can increase revenue faster than our indirect costs, we improve year after year. Strong growth in the second half has really supported our cost management. We anticipate continued growth for the remainder of this year. The key challenge is keeping costs from rising faster than revenue growth. We also have some costs that increase with our workforce size. One of our strategies has been to reduce our reliance on personnel for growth. We’ve discussed the need for a more diverse product mix, which helps us grow in a nonlinear way alongside our workforce. As we ramp up production in Dynetics, we can take advantage of our excellent team without a direct correlation, allowing us to grow more rapidly than our indirect expenses, which include HR, benefits, and training programs. That summarizes our approach. Chris mentioned the fixed price and cost-plus structures, and I’m sure you’re familiar with the mechanics of how we need to respond based on the contract type.

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

Yeah.

Thanks, Ken.

Our next question is from the line of Cai von Rumohr with Cowen & Company. Please proceed with your questions.

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

Well, Cai, I mean, keep in mind, first of all, half of our revenue is kind of Leidos content. We've got subcontractors. We've got materials, right? So that's only a portion of the business that you're focused on the headcount growth. And that headcount growth that Roger talked about, the 2,400 people that we brought on last year was over the course of the year, right? We were adding them kind of pro rata throughout the year. So it's not like that's going to all be incremental heading into '23. But that being said, we have big plans around the additional heads that we plan on adding again this year. So the combination of factors, headcount should be up. You're correct. There's payroll growth on top of that, that gives you some upside, that immediately gets passed through on the cost reimbursable programs. You don't necessarily get uplift immediately on your fixed price programs. But that's part of the equation, too, that would suggest, if we're successful, we don't have any major losses, and we continue to win our fair share, we like the momentum that we see on the growth side.

Thanks. And the second one is, you have very strong bid submits. And Roger, you mentioned we have a very strong FY '23 budget. So there's lots of money available. Can you give us some color on what you expect your book-to-bill might be in '23 and what that would suggest for '24?

Sure, Cai. It's still early, and we have about $34 billion in pending awards. Last quarter, we submitted around $23 billion, which may have been a record for us. We have many opportunities ahead, and we anticipate that 2023 will meet or exceed our performance in 2022. However, it's early, and sometimes we face protests that can push programs from 2023 to 2024, as we have experienced in the past. Nevertheless, we are optimistic that 2023 will be strong and at least match 2022 levels. There are always uncertainties, and there are a few opportunities that could significantly boost our results, although we haven't included those in our plans or guidance. We aim to create a balanced guide based on our current portfolio. Historically, we have maintained a book-to-bill ratio above one, and we see potential for a very strong year. We also have pending projects, including fans, which we hope will be awarded soon. Without going into specifics, there is a program currently under protest that we expected to be awarded in the first quarter, but the customer has asked us to extend our pricing to next year. While we are enthusiastic, we occasionally face setbacks due to protests, and this tends to temper our optimism. In the first quarter, we will be cautious about what we share. We have a backlog of 35 to 36 billion and 34 billion awaiting award, along with strong submissions. We expect 2023 to be a very strong year for submissions as well.

Thank you very much.

Thanks, Cai.

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

Hey. Good morning, everyone. Just want to follow up there with kind of a follow-up question to the line of thinking that Cai had there on the bookings. You mentioned in your prepared remarks the protracted acquisition process that's in place. That's something we've been hearing for quite some time now. I'm wondering if this is just kind of the normal environment now? And what your assumptions are for the year? Are you expecting things to get better or worse on how quickly things can get out the bid and then awarded?

Yeah. I mean, I'll talk kind of top-level. Chris can add in. And this is just what I think. So everybody has their opinion — there's a lot that's being written is what I think I'm seeing is customers wanting to get things under contract before we end up in this argument over the debt ceiling. With looming government shutdown, who knows what comes out of those discussions. If you've got a customer and you've got appropriated funds, you're going to really work hard to get those committed between now and June. And so we are seeing a little bit more activity, and we're hopeful that these folks will try to move a little faster and get these things under contract. And then we probably end up with an agreement on debt ceiling with some kind of a future trade on some kind of a top-level budget constraint. I mean I don't — I'm not smart enough to know what that will look like. Last time this happened, we got sequester. But I suspect it will be something just what I read about how McCarthy got elected as a speaker, there is some kind of a budget deal that's going to be cut for the long term. But that could be by — and I don't really understand how you balance the budget in 10 years. Again, that's not my job, but I run the numbers, and it seems unbelievably difficult. But that's going to put a damper perhaps on what the budget could be. You're starting to talk now 25%, right? And so I suspect that if you have money and you have a program and you have a mission with requirements, you're going to work as hard as you can to get those things committed in '23. And I think that speaks well. And then as you know, we get an award in '23 that's a '24, '25, '26 revenue. So again, our future, we think, still looks relatively bright. And then plus the diversity in our portfolio, the Civil group has been growing very strongly. The health group has been growing very strongly. So we've been working really hard to make Leidos somewhat resistant to the vagaries of what happens from our elected officials. I don't know, Chris, you want to add anything?

No, I think you covered it well. I mean the only thing I'd say, we wish customer contracting shops were more fully staffed. They're not in many cases. One path that we think has been successful is more use of Fed Sim. Fed Sim runs a good acquisition process, the rules are well defined. And so we've had some success with our teams competing in that arena, and we see more customers going in that direction.

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

Yeah. Good question, Jason. So it does. When we acquired the Australian airborne business, we knew they were kind of halfway through a major investment in the mission management system software capability. We're continuing that investment. So that will be completed in '23, but that was fully factored in the valuation of the business. And so that's elevated for a period of time. Then as you know, I mean, just like the rest of Arbor business, there will be some preventative maintenance, ongoing normal maintenance CapEx that we'll spend there over time. But think of that as slightly elevated in '23, just to continue the full development of that capability. And then we've got additional CapEx in that number for our U.S. based airborne business as we're acquiring more capability, fitting it out to run more mission, and we're optimistic on some bids that we've put forward and some more that are in the pipeline there.

Great. Thank you.

Thanks, Jason.

Hey, Rob, we're running a little bit over, but we have time for one quick question.

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

Roger, Chris, Stuart and Gabe, good morning.

Good morning.

Good morning.

The success of drones in Ukraine and more recently, surveillance balloons have increased Congress's focus on unmanned systems last summer, on a $300 million contract to develop a medium unmanned undersea vehicle for the Navy, and your unmanned surface vessels Sea Hunter and Shaw have participated in several successful demonstrations. Is there potential, Roger, for some of these Navy unmanned platforms to convert to programs of record, or even for Leidos to provide surveillance as a service similar to the cocoa model that you're doing in the U.S. and in Australia? Thanks.

Yes. Well, that's great. I mean Louie, you really are following things well, and I think you really understand our programs. I would add to that, we have some unmanned vehicles that are made of Dynetics. By the way, we have some counter-drone programs that we probably exposed to a little bit too when you were down in Huntsville, where we actually have a radar on Jeep and we launch a drone, and it can go — or attack another drone. And so — but we see exactly what you see is the use of uninhabited vehicles under the water on the surface in the air, and we'll call it in the rare air, up between 60,000 and 80,000 has — first of all, I will tell you that it has been robust. There's been a lot of work already done. The MUUV is a program of record. So we won that, that's a program of record that's fully funded. The Sea Hunter and the autonomous vehicles in the Navy are not yet programs of record but the Navy is doing a lot of experimentation. They're doing some things in the Mid-East that have really demonstrated some capabilities. As you have mentioned, we've done a lot with Sea Hunter, Sea Hawk, and Sea Innovator. And we believe there is a strong demand for those. I think for us, on the surface. The next thing for us may not be a full program of record, but they may buy additional vehicles to extend their experimentation, which they can do under an OTA that would happen much faster. But I believe that the Navy is committed to having a significant percentage of their fleet both unmanned and optionally manned. And our autonomy software and the things that we have demonstrated really set us up well to capitalize on that and to bring them the capability that they need. There are a couple of other programs. There's MUSV, there's LUSV that are out there. They are going through their development processes. But to get all the way to the program of record, I think, is years away, but that doesn't mean that the Navy won't be spending funds to further their understanding and to experiment with unmanned capabilities, and we would be right in the middle of those activities. So Louie, thanks for the question.

Thanks, Roger. Thanks everyone.

At this time, I'll turn the floor back 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.

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