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Presentation

Operator: Greetings and welcome to Leidos First Quarter 2024 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. Please note this conference is being recorded. At this time, I’ll turn the conference over to Stuart Davis from Investor Relations. Stuart, you may begin.

Stuart Davis: Thank you, operator, and good morning, everyone. I’d like to welcome you to our First Quarter Fiscal Year 2024 Earnings Conference Call. Joining me today are Tom Bell, our 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 includes 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 Tom Bell, who will begin on Slide 4.

Tom Bell: Thank you, Stuart, and good morning, everyone. It’s very good to be with you again today, and I’m thrilled to report a very robust start for Leidos in 2024, a substantial raise to our full year guidance and some additional details around the purposeful steps we’re taking to position Leidos for an awesome future. The Leidos team got out of the starting blocks impressively this year, addressing our customers’ most vexing challenges with passion and pace and as a result, delivering an excellent quarter of top and bottom line results. First quarter revenue grew 7.5% year-over-year, all organically. First quarter adjusted EBITDA margin was 12.3%, a record for Leidos. And year-over-year non-GAAP EPS grew 56%. These results demonstrate that our new capability based organization is unlocking significant value across the company.

With good cash generation, as promised, we began our 2024 stock buyback program by repurchasing $150 million worth of shares on the open market during the quarter. You’ll remember that during our last earnings call, I framed our initial 2024 guidance against the backdrop of a very good year for Leidos in 2023 and a very uncertain 2024 customer budget environment. Happily, since then, the House and Senate have passed appropriations for all the federal government. And now with funding in place, our customers have the resources and direction they need to confidently execute their missions. With that certainty in our customers’ budget, the quick success of our organizational realignment and our team’s strong start to the year, we have increased confidence in our near-term growth prospects.

As such, we are significantly increasing our 2024 guidance and now expect to far exceed our previous multiyear financial commitments. Chris will detail our new 2024 guidance later in the call. As I round out my first year at the helm of Leidos, I remain impressed with the capability of our people to deliver for our customers and shareholders. Over the last four quarters, revenue has grown 8% and non-GAAP EPS has grown 25%. We’ve delivered adjusted EBITDA margins of 11.5% and free cash flow conversion of 109%. And we’ve maintained rigorous investments in IRAD and business development. I’m very pleased that we’ve been able to refine the conversation about what’s possible here at Leidos, especially around profitability. Leidos is indeed a healthy business.

So for the remainder of my prepared remarks, I’d like to share some additional details about the purposeful steps we are taking to position Leidos for an awesome future. We are achieving and propelling superior profitable growth by focusing on three key elements. First, continuing to unlock full value and flawless execution in our new capabilities focused organization. Second, increasing investment in distinct organic disruptive technologies. And third, developing a robust value creating merit based Leidos profit and growth strategy. Let me walk through each of these elements with you. First, we’re very happy with the quick wins we’re achieving from our capability based organizational realignment and we are anticipating that this move will continue to unlock significant value going forward.

For example, by consolidating our commercial and international business into a single segment for the first time, we’re now better able to truly serve our global customers. In February, I had the opportunity to attend the Munich Security Conference. It was a sobering affair, which made abundantly clear that pervasive global threats are in fact growing. And our collective efforts to help our allies and partners are becoming even more crucial. To give you an idea of where and how the new Leidos can help, global battlefields of the future demand ever more cross domain interoperability and leading edge technical solutions. As we collaborate with our customers and allies around the world, we gain valuable insights into their interconnected issues across borders.

Our realignment, which integrates all our international customer touch points into one organization enables us to better correlate and quickly respond with a whole of Leidos solution to their critical emerging needs. Also, globally, the AUKUS, trilateral security partnership represents a unique opportunity for Leidos as Australia, the UK and the US seek to work even more closely together. The focus of AUKUS Pillar 2 is seamless information sharing, AI and autonomy, advanced cyber, hypersonics and electronic warfare. This list reads like a catalog of Leidos strength. We believe Leidos through our new commercial international segment is uniquely positioned to serve these ambitions like no other. Second, we will continue to accelerate investment in distinct organic disruptive technologies.

On my first earnings call, I highlighted technology innovation as a core of Leidos. Nearly a year into this role, I can confidently reaffirm that the technology prowess at Leidos is impressive, broad and deep. Continually sharpening our portfolio of cutting edge technologies, what I call golden bolts to lead turn the market will remain foundational to our North Star. At Leidos, innovation is everywhere, but we have a particular passion and focus on remaining best-in-class in three technologies trusted mission AI, full-spectrum cyber and secure rapid software. In each, we maintain a robust IRAD pipeline in what we call accelerators, staffed with incredibly smart people who work across the entire customer solution set. And we combine the resulting immense organic technical prowess with a best-in-class commercial partnership program to truly bring making smart smarter to life.

Let’s talk about one of these accelerators. Trusted mission AI spans the breadth of our portfolio and is integral in practically all our customer solutions. Our trusted mission AI solutions work as a partner to humans in transforming the way we deliver high quality, rapid, and secure outcomes for our customers’ most complex missions. For example, across the intelligence community, we have several large classified contracts where we’re leveraging trusted mission AI to exploit vast amounts of data to address ever-changing national security challenges. In the cyber realm, our team of experts has spent the last three years developing the next generation of defensive cyber tools. These tools use AI to automate the discovery of new vulnerabilities and the development of novel defenses.

This unique solution allows us to proactively deploy defenses before attacks occur, crucial in foreseeing, averting and defeating cyber risks. In defense systems, trusted mission AI is the enabling technology that anchors all our autonomy work. We’ve built the first generation of autonomous vessels for the US Navy, several of which recently transited the Pacific twice as part of a manned unmanned task force, and we’re now applying this proven trusted mission AI technology to the next generation of unmanned surface vessels. In software and IT, we’re leveraging our exclusive relationships with key emerging technology providers to bring the best of the latest generation of generative AI to our customers. This enables us to uniquely position our customers to operate more efficiently, delivering real quantifiable impact.

Let me share a couple of examples here. Our partnership with Sourcegraph leverages their commercial cutting edge Gen AI coding assistant to transform the way we develop software. In just a few months, by combining our unparalleled government customer knowledge with their tool’s power, we’ve proven productivity increases in software development of one-third. And we know these solutions are deployable even into the most secure customer environments. Our exclusive partnership with Moveworks gives us a differentiated ability to bring our customers the best in Gen AI-based IT service desk solutions. We’ve already deployed their technology within the Leidos IT environment and have completely automated processing of thousands of service requests. Our focus on integrating trusted mission AI into our customer solutions rather than just selling AI labor positions us uniquely to meet the growing demand for AI solutions across our customers.

I trust these examples begin to give you a sense of our leadership position in all our golden bolts, but especially trusted mission AI. But if you’d like to see more of our solutions in action and meet some of our wicked smart people, I invite you to an investors event we will be hosting here at our global headquarters in Reston on 12 June. Finally, I’d like to give you an update on the development of our strategy for Leidos’ second decade of growth. As I mentioned during our last call, this is a year of deep, formally structured strategic conversations across the whole of the business. And while this effort will not be complete until early next year, I did want to share with you now some high level principles that are guiding our work. Principles of our upcoming strategy will be doubling down on our core strengths, seeking to exploit the power of repeatable business models, making speed a conscious competitive discriminator, differentially investing in the areas of greatest potential, building trusted mission AI into everything we do and uncovering unique opportunities to expand Leidos into logical, closely adjacent growth markets.

These guiding principles will enable us to stay true to what we do best while being quick to respond to the opportunities that are emerging at pace in our market. Also of note, importantly, as we think about our strategy, we will continue to view our balance sheet and cash generation capacity as key strategic assets. I remain committed to a disciplined capital management and deployment policy, continuing a focus on shareholder returns in the near term. In closing, we’re off to a great start this fiscal year. We are committed to building on our successes and deliver smarter outcomes for our customers, shareholders and each other. As we continue to push the boundaries and challenge ourselves to think bigger, I am confident that 2024 will be Leidos’ best year so far.

We’ll see tremendous achievements and a crystallizing compelling growth strategy. With that, I’ll pass the call to Chris to discuss our financial results for the first quarter and our financial promises to you for the full year. Chris?

Chris Cage: Thanks, Tom, and thanks to everyone for joining us today. The first quarter operating in our new organization was a great one, far surpassing our initial expectations. While Health and Civil was a standout, each segment’s relentless focus on innovation and operational efficiency led to above planned performance in revenue, profit and cash in every reporting segment. Putting these results in the context of the full year, we are well on track to deliver an exceptional year of top and bottom line performance. Turning to the income statement on Slide 5. Revenues for the first quarter were $3.98 billion, up 7.5% year-over-year. With appropriations in place, our teams are working with their customers to execute on vital missions.

Strong top line growth in the first quarter enabled us to achieve record profitability. Adjusted EBITDA was $490 million for the quarter, up 42% year-over-year and adjusted EBITDA margin increased 290 basis points to 12.3%. Non-GAAP net income was $313 million and non-GAAP diluted EPS was $2.29, up 53% and 56% respectively. This explosives earnings growth was the result of core operating performance. The net impact of a slightly lower net interest expense and share count was wholly offset by a slightly higher tax rate compared to the prior year period. This bottom line performance not only boosted our cash flows, but it put us in a favorable position to continue reinvesting across the business to support the execution of our longer-term strategic objectives.

Turning to the segment drivers on Slide 6, national security and digital revenues increased 2% year-over-year. The largest growth catalysts were increased volumes on the Sentinel and DES programs, which more than offset the Focus Fox loss early in 2023. National security and digital non-GAAP operating income margin increased 120 basis points from the prior year quarter to 10.1% with some milestone achievements, strong cost control and excellent program execution. Health and Civil revenues increased 19% over the prior year quarter and non-GAAP operating income margin also came in at 19% up from 12.2% a year ago. The primary driver of revenue growth and increased profitability was higher volumes across our managed health services portfolio. We entered the year with tempered expectations around medical exam volumes, but we’re seeing increased complexity on PACT Act cases and although we’re investing heavily to drive throughput, the team did an amazing job at improving efficiency, optimizing resources and delivering exceptional service to the nation’s active duty members, reservists and veterans.

Commercial and international revenues increased 4% and non-GAAP operating income margin was 8.3%, up 360 basis points compared to the prior year. We had increased deliveries of security products and we’re seeing the impact of the changes we made in the SES business including a leaner cost structure, improved supply chain and rationalized product and geographic portfolio. Though our work is not done in fully optimizing the security products business, I’m proud of the team for their performance and recovery since this time last year. Finally, defense systems revenues increased 7% year-over-year with increased volumes in our Airborne ISR and Hypersonics businesses. Defense systems’ non-GAAP operating margins of 8% declined 170 basis points over the prior year quarter, but were up 30 basis points sequentially and we remain committed to margin improvement for this segment for the full year.

Turning now to cash flow and the balance sheet on Slide 7. We generated $63 million of cash flow from operating activities and $46 million of free cash flow. DSO for the quarter was 62 days, unchanged from a year ago. In Q1, we repurchased a net of 170 million worth of shares including 150 million on the open market and paid 53 million in dividends. We ended the quarter with $633 million in cash and cash equivalents and $4.7 billion in debt. Our gross leverage ratio now sits at 2.6 times, comfortably below our three times target. On to the forward outlook on Slide 8. As we look ahead to the rest of the fiscal year 2024, we are poised to capitalize on the momentum we’ve been building. Based on our strong Q1 and improved outlook, we are raising our 2024 guidance for all metrics.

We now expect revenue between $16 billion and $16.4 billion, an increase of $300 million to the range. Our new adjusted EBITDA margin range is mid to high 11%, which would be record profitability for a full fiscal year. With an improving revenue and margin outlook, we’re raising our non-GAAP diluted EPS by $0.90 to a new range of $8.40 to $8.80. And finally, we’re raising our operating cash flow target by $200 million to approximately $1.3 billion for the year. Underpinning this updated guidance is a positive outlook on business development. In the first quarter, we booked a net of $3.7 billion, which translated to a book-to-bill of 0.9 times for the quarter and 1.1 times for a trailing 12 months. The quarterly bookings total excludes a multibillion dollar classified award that is currently under protest and a $630 million Defense Systems award received on April 1st, both of which are new work for Leidos.

We’re seeing positive business development momentum and we expect our awards this year to support our growth objectives. Finally, let me give you some sector specific movements that color our full year guidance. On the fourth quarter call, we highlighted that Health and Civil had the potential to outperform if medical examination volumes remained high. Since then, volumes have actually increased given the complexity of PACT Act cases. The second quarter should see similar levels of performance or even a little better. However, as a result of the increased volumes, the VBA has burned through some of its contracts sooner than planned and will have to recompete them early. We are well positioned to continue our best-in-class service as a longstanding, trusted mission partner to the VA, but we are planning for performance in the Health and Civil segment to moderate in the back half of the year through the competitive process.

First quarter revenue growth in the Defense Systems and Commercial and International segments was more robust than anticipated. Although we see some potential for growth in both segments, we still see the full year revenue performance as relatively flat. In Commercial and International, some of the SES geographies and products we exited will begin to weigh on revenue and defense systems is still working to mature some of its developmental programs. Taken together with funding certainty, positive demand signals, and the performance seen across all four segments this quarter, we feel confident in our ability to deliver within these new ranges. With that, operator, we’re ready to take some questions.

Operator: Thank you. [Operator Instructions] One moment for our first question please. Our first question comes from the line of Bert Subin with Stifel. Your line is now open.

Bert Subin: Hey, good morning. Thank you for the questions.

Tom Bell: Good morning, Bert.

Bert Subin: Tom, when you started, I guess, about a year ago, you said you wanted to evaluate allocation of capital to each business based on the business case supporting the return for — return on capital for each. It would seem like capital is being put to best use right now in Health and Civil. Is that a near-term phenomenon being driven by the PACT Act? Or is there a case for that business to be your fastest growing and most profitable longer-term as well?

Tom Bell: Yeah. Thanks for the question, Bert. I did say that and I do believe in a merit based strategy process. I mentioned that in my prepared remarks because what we are doing in 2024 as we undertake this year of deep strategic thinking is analyzing all the business cases and the sub-business cases for where the best use of capital is to draw superior top line and bottom line growth for Leidos. And so as a result, we’re able to put some seed corn in areas that are emerging in this year even though the strategy process is not done. And yes, in fact, the investments we’ve made in our managed healthcare business is absolutely paying dividends now and that is the reason that business under Liz’s leadership has been so well positioned to respond to the increased demands that have come our way.

So we’re very excited about the strategy process we’ve got underway. We’re very excited about the ideas that are emerging from that strategy process. And we’re seeing great benefit of past decisions we made through last year about where to invest, how to invest and which businesses to position for future growth. Chris, did you want to add anything to that?

Chris Cage: Bert, I just — obviously, the Health and Civil organization has been a standout and we do see that momentum continuing. And to Tom’s point, it’s been a multi-year investment strategy that’s positioned us to be where we are and to deliver excellent results for our veterans and be rewarded for that. But there are other parts of the portfolio we’re very excited about too. And so I wouldn’t limit our thinking and our investments to solely focus on Health and Civil. And at the same time, some of the Health and Civil organization results have benefited from investments we’ve made in things like AI and other capabilities at the center that apply broadly. So you’ll see those strategies continue and you’ll see us continue to accelerate those investments as the year unfolds.

Bert Subin: That’s great. Thank you. And Tom, you spent — and Chris, you just mentioned it there. You spent several minutes in your prepared remarks talking about AI. I think one of your peers gets a lot of credit for sort of being the leader in the industry of AI and has taken some steps to break out like what their sales are and how it impacts their win rate on certain contracts. It seems like you’re pretty confident in what you’re doing there and it would seem like it’s helped quite a bit on your — in your Health business with the VA. Are there some examples or is there some sort of numbers you can give us related to AI just to sort of think better about your positioning as we go forward?

Tom Bell: Well, thanks, Bert. Yes and yes. The fun thing about capitalism is many people look at the same market and decide to prosecute it in different ways. We’re aware that our competitors are looking at selling AI labor and think it’s a market unto itself. That’s not how we see the world. We see the world as difficult customer challenges and we saw ourselves as solution providers into that space. We see trusted mission AI as a huge key enabler to unlocking superior value for our customers in the solutions we bring forward. So we’re going to continue to avoid breaking AI out as a specific target. But in the spirit of your questions, I can share with you some antidotal evidence. For instance, while we’ve been investing in AI, the deployment of that has enabled us to improve quality on about $1 billion of those health exams.

In other words, some of the throughput we’ve been able to have in our clinics is the direct result of the efficiency that the AI tools we have embedded in our solutions unlocks. We’ve been able to put AI in our SES airport security business by linking things together there. We’ve been able to put AI in our unmanned systems, command and control systems that’ll enable us to help unmanned systems quickly speak to each other and aggregate their effects. So we’re going to continue to see trusted mission AI as not an end, but a means to serving customer missions. And I hope that differentiation is something that you can join us on the 12th of June to understand even more.

Bert Subin: Thanks, Tom, and thanks, Chris.

Chris Cage: Thanks, Bert.

Operator: Thank you. One moment for our next question please. Our next question comes from the line of Tobey Sommer with Truist Securities. Your line is now open.

Jasper Bibb: Hey, good morning. This is Jasper Bibb on for Tobey. I think last call you talked about the initial mid to high 10% guidance range on margin as a base to sustainably grow off. And then you raised the ’24 guidance significantly this quarter. So I guess, looking forward, how are you thinking about progression of margins given the progress you’ve already made this year?

Chris Cage: Yeah, Jasper, thanks for that, right. Obviously, we’re very pleased with the start to the year and as in our prepared remarks, we indicated it wasn’t just the Health and Civil business, it was really all of our teams got out of the gate strong. And so now our full year outlook has been updated to mid to high 11%. We think that’s an area that obviously we’re ahead of that in Q1 but that’ll be strong performance across the business as the year unfolds. And you think about some parts of the portfolio, for example, commercial, international and defense systems both of which had good first quarters, but aren’t yet where we expect that they will be on a margin performance basis. So there’s uplift there over the course of this year and into the future and for Health and Civil, sustaining this level of performance through Q2 is what we indicated and we’ll have to see how the competitive process plays out on the recompetes in Q3, Q4.

But there is the potential for that business to continue this momentum certainly through the back half of this year and into ’25.

Tom Bell: Just pivoting off of that a little bit. I want to give a shout-out to the team for how they’ve embraced this whole concept of a promises made, promises kept culture. So while we have a standout first quarter performance in our Health business, they are not the only business committed to continuing to perform through the year. So we’re very confident in our ability to hit the current range and we’re very excited about the degrees of freedom that gives us to invest differentially in our future and really propel our next growth strategy to great heights.

Jasper Bibb: Thanks. That makes sense. And then you mentioned the improvement in managed health programs for Health and Civil segment this quarter. I guess just curious what the trends were on the legacy civil side of the segment as part of the growth in margins you demonstrated in the first quarter.

Chris Cage: Yeah, the civil part of the portfolio has some excellent programs in there and as Liz and the team are bringing that all together, it’s more about the energy and the synergies that we see across those businesses on personnel and software capabilities that can be extended to both sides of the equation. I wouldn’t say there’s any particular standouts in the civil portfolio. It was a solid first quarter out of the gates and we’re looking forward to building on that momentum as the year unfolds especially in as we look at our FAA business and where that can extend capabilities to certain international customers, et cetera, as a particular area of interest for us.

Tom Bell: But I can’t let that question not go without a little bit of a footstomp on the great performance we’re having in the Health side of the business. We are continuing to invest in innovation there. And some of the innovations that Bert asked us about before that were built during the COVID crisis puts us in this position to do exams better for the VBA. And some of the results that are behind the financial results are that Leidos investments have allowed us to increase the total number of veterans served by 27% in 2023. And as Chris mentioned in his comments, the volume is even increasing now in 2024. More than just that, we’re able to serve our rural veterans better by 33%. And we’re able to serve our homebound veterans by over 55%.

So the investments we’ve made in technology and capability to take the clinics to the veterans are serving our veterans in ways that are enabling us to then unlock volume and unlock financial results. We’re very excited not only about the whole of Liz’s portfolio, but this part of the portfolio in particular.

Jasper Bibb: That’s helpful. Thank you for taking the questions.

Tom Bell: Thanks, Jasper.

Operator: Thank you. One moment for our next question please. Our next question comes from the line of Sheila Kahyaoglu with Jefferies. Your line is now open.

Sheila Kahyaoglu: Thank you. Good morning and kudos to the Leidos board for choosing the right candidate. Clearly, Tom, great results, for the whole Leidos team. So maybe on Health, we talked about it a little bit, and Chris mentioned it in his remarks in terms of the PACT Act moderation, can you maybe frame how we should think about the upside and downside scenarios there?

Tom Bell: Yeah. So, you know, the PACT Act volumes are racing forward. We’re in a unique position to liquidate that volume on behalf of the Veterans Administration. Feel very good about that. But as Chris mentioned in his comments that puts pressure on reaching the contract ceiling value for the Veterans Administration. And they may have to and they will have to recompete that contract early. However, we’ve got a great position for that recompete. We feel very confident in the technology, the capabilities and the team we have assembled to continue to serve veterans in this nation. And so while, as Chris said in his comments, we’ve provisioned for some slight moderation in profitability in the second half of the year just because of the competitive dynamics and are being unsure of exactly how the Veterans Administration is going to put that RFP out, we feel very good that that’s a business we’re in.

That’s a business we can continue to grow and that’s a business that we can continue to serve our nation and its veterans very robustly. Chris?

Chris Cage: Yeah, Sheila, I’d just add, I mean, we have invested, we’ll continue to invest in increasing our ability to drive throughput and drive excellent service for the Veterans. We’ve got the strongest signal yet from the customer that the volume of activity should remain elevated and we see that continuing into 2025. And it’s not just the number of cases, it’s the complexity of those cases. So we believe still in the early innings of where this thing can play out and we’re going to continue to invest accordingly to make sure Veterans are well served with great experiences. I would say that even our first quarter results which were quite strong, it wasn’t aided by incentive fees as part of that too. So there’s still some opportunities to drive that performance higher over time. So really like how we’re positioned in that business right now.

Sheila Kahyaoglu: Thank you. And then maybe on defense systems’ margins, they were better sequentially, but down 170 bps year-on-year. So how do we think about maybe just focusing on Dynetics, the key milestones there in terms of improvement in profitability?

Chris Cage: Yeah. So, I mean, a couple of things we’re tracking and Cindy leading that business is all over this with her team. But as we said in our remarks, we’re actually pleased with the way we performed out of the gates in the first quarter. We’re ahead of pace. There are some specific things we’re focused on to drive margins higher over time, one of which we just completed at the end of last year getting Dynetics fully integrated into the Leidos set of systems, whether that’s financial, HR, et cetera and our rate structure. And so there’s a lot more collaboration, resource sharing, efficiencies that are unlocked as part of that. So that’s very exciting. Program execution. It’s the strength of Leidos and it’s an area that we’ve seen improvements in talent upgrades and process upgrades and that’s an area that we can identify mile markers along the rest of this year that’ll drive our program performance higher and our profitability higher as the year unfolds.

And then finally transitioning into next phase of key programs. You know, we know sometimes on developmental programs, the early phases are not the most profitable lessons that are learned and those are applied into the next round of bidding. And I think the team has incorporated those and we feel good about the bids we’ve been putting out and are well positioned to win, to keep growing that business.

Tom Bell: Yeah. And just to footstomp that a little bit, Sheila, I mentioned in — as I footstomped an earlier comment about all the businesses keeping up with their commitments to Chris and I for their full year performance in the promises made, promises kept, modus operandi. And I’m very happy to report that Cindy is amongst them undeterred by a less robust start to the year than perhaps we might have hoped for but very committed to the full year results and she and her team are committed to meeting or exceeding those.

Sheila Kahyaoglu: Thank you.

Operator: Thank you. One moment for our next question please. Our next question comes from the line of Seth Seifman with JPMorgan. Your line is now open.

Rocco Barbero: Good morning. This is Rocco on for Seth.

Tom Bell: Hey, good morning.

Chris Cage: Hey, Rocco.

Rocco Barbero: On margins, milestone achievement supported the national security and digital margin in the quarter. Should we expect additional milestones in the coming quarters, or should the margin rate there normalize? And then on Health and Civil, Q2 is expected to be as strong as Q1. But should we think about the back half falling into the mid-teens on margins seen historically in the business obviously pending that recompetes?

Chris Cage: Yeah. Rocco, I’ll start. And Tom can footstomp. Obviously, national security and digital, excellent program execution is what we expect from that team because they’ve consistently delivered it. And sometimes you’re not able to anticipate that you’ll knock it out of the park on award fees the way they have continued to do so. But I wouldn’t bet against them. So we’ll continue to see program execution as a strength there and as it relates to Health. Yes, when we — Health and Civil, when we started the year, we signaled there in the mid-teens was a reasonable expectation for the year. We’ve exceeded that. We’ll continue to exceed that level through Q2. And I think that even the second half of the year, there’s the possibility and potential it could be better than that and we’ll be able to give you some better color on that as we get closer to the recompete process.

Tom Bell: Yeah, I would just say that my whole promises made, promises kept, culture never uninvites over performance. And so overperformance is welcomed. Overperformance is understood as a goal we all look to achieve. And I have every confidence Roy and his team are going to work to overperform both in this year and the future. We haven’t talked about it yet but our business development pipeline is very exciting and very robust and nowhere is it more robust and more exciting than in Roy’s business, in our national security and digital space. So he and Steve are working very hard to make sure we are positioned to win in the marketplace in the future not only to deliver results now but to deliver results for the next five years.

Rocco Barbero: Great. Thank you. And then should we expect hypersonics to drive defense systems’ growth this year or when that business is changing to limit growth?

Tom Bell: Well, hypersonics is one of several areas that we’re focused on in our defense systems business. And, yes, we’re very excited about the capabilities we’ve proven in our hypersonics programs. And in fact, this week we’re having very robust conversations with customers around where they want to go and how they want to take that technology forward. Obviously, it’s a wicked hard problem but we’ve got our wicked smart people working to solve them with and for the customers. But that’s not the only one. We’ve obviously got a lot of expectation with regard to IFPC Enduring Shield. That program is progressing well through the army test program this year, and we’re very hopeful for an LRIP decision at the end of this year. And, you know, Wide-field of View Tranche 2.

While we were disappointed that the prime for our payload wasn’t selected, we’re working several avenues to maintain our prowess in that market and serve our nation in their understanding of what’s happening from a threat standpoint. So our defense business isn’t only hypersonics, but hypersonics is one of those areas. And we’re very excited about the suite of capabilities we’re currently focused on necking down to and prosecuting effectively.

Operator: Thank you. One moment for our next question. Our next question comes from the line of Matt Akers with Wells Fargo. Your line is now open.

Matthew Akers: Hey, good morning, guys. Thanks for the question. I wonder if you could comment on the security products business. I think you said in the prepared remarks there’s still work to be done optimizing that. So just curious you could touch on. I think you were in-sourcing some products. You talked about that last year. Then kind of how big should we think about some of these products that you’ve decided to exit?

Tom Bell: Yeah. Thanks for that, Matt. We are very, very proud of Vicki and her team and the swift actions they’ve taken through last year and since last year. They’re engaged. They’re excited about the opportunities they see. And I’m very happy that they’re not looking at that world through rose-colored glasses. They are being positively inclined pragmatists looking at the market for what it is and looking at how we prosecute that market in the Leidos way to the best, to the best degree possible. We did exit certain geographies, as we talked about last year and we continued to refine the products we’re actually offering into the marketplace because we decided those had become commoditized and they weren’t a great place for Leidos to perform.

But while it’s still early innings, we’re very excited about the business. We’re spending a lot of time on the strategy for how and where we grow that business into the future. And we’re — we expect that to be a part of our conversation as the strategy unfolds through the year and into next. Chris, anything you’d add?

Chris Cage: Yeah, Matt, I would just add. I mean, we’re excited about getting our Charleston facility up and running and the team’s been doing a good job there. Actually, the leadership team will be down there next week to lay eyes on it ourselves. So we’re looking forward to seeing that. There’s a variety of products. I won’t get into specifics about which ones we’re pulling out of the portfolio, but clearly, we’re focused on where we have technical differentiation, leadership positions, people screening has been a strength of that business for a long time. You can imagine that’ll be something we continue to stick with and double down on. We have excellent suite of port and borders equipment, but there’s some pockets of the check baggage, checkpoint baggage, et cetera, that we just have to continue to evaluate where we’re positioned and make those changes accordingly.

Matthew Akers: Great. Thank you. And then I also want to ask on CapEx, a little bit of a slow start to the year. I might have missed it, but is $190 million still the right way to think about that for this year? And does that sort of ramp up through the year?

Chris Cage: Yeah, Matt, that’s still our budget and there’s a little bit of reserve in there. And we ask the teams to be smart and disciplined even when we allocate them approvals, but you’ll see a few things ramp up. We’ve got our San Diego facility that we’re going to be proud of to get a brand new facility for a lot of our classified work out in San Diego completed this summer. And the teams are also looking for interesting ways that we can get in front of the customer on unmanned capabilities, demos, test beds, et cetera. So we expect that to ramp up a little bit, but we’ll continue to manage that tightly.

Matthew Akers: Okay, great.

Tom Bell: Chris mentioned San Diego a little bit. I’ll just footstomp the great job the team is doing there. We’re building a facility that will be world class in terms of security and up to the latest standards of our nation. And so we’ll have facilities on the West Coast that are as good as any and better than most. And we’re very excited about the conversations and the opportunities that will unlock for us with our customers and the opportunity, therefore, to serve them at the highest classification levels.

Matthew Akers: Great. Thank you both.

Operator: Thank you. Our next question comes from the line of Noah Poponak with Goldman Sachs. Your line is now open.

Noah Poponak: Hi. Good morning, everyone.

Chris Cage: Hey, Noah.

Tom Bell: Good morning, Noah.

Noah Poponak: So I guess on the margins the — in the quarter, the total company EBITDA margin over 12%. Despite what you’re saying about defense systems and the back half of last year, kind of mid-11s with the same thing and a little bit more normal health margin, I guess, just without even putting a time frame on it. But just as you go forward beyond this year, should we all be thinking of Leidos as a 12% plus EBITDA margin business or is that getting ahead of ourselves depending on where Health and Civil shake out?

Tom Bell: Well, no. We’re not in the point where we’re guiding to 2025 and beyond. But I remember last year when we were wrapping up the year, we were talking about us being high-10s, high-10s business, and people were chastising me for suggesting we might be over 11. Now we’re proving we can be over 11. And I’m very eager to see what the full potential of this business is. That’s not a commitment to maintain margins at a certain level. We’re going to make smart decisions. We’re not going to get locked into certain preconceived notions of where we want to go. But better is always good. And we want to bank those gains and expand and exploit other areas to grow the business. So as we’ve guided this year, high-11s is our commitment to you in 2024. And as we prosecute 2025, we’ll be very eager to see if we can meet or better that. Chris, anything?

Chris Cage: Well, mid to high-11s. Tom, I just want to make sure the team doesn’t run away from us here on their models. But no, your points are well made. I think that we have lines of business that haven’t reached their full potential and we’re driving them in that direction and capitalizing on the gains we’ve made. We’re going to continue to invest, to stay ahead of demand. So those are things that we’ll have to evaluate where those opportunities are Noah. But clearly, you can see this business has a lot of potential and we’re going to continue to unlock it.

Noah Poponak: Okay. And Tom, you sound pretty positive on bid and proposal. It sounds like you’re making changes there as well. The company’s had a lot of growth in the all-in-total backlog number. It’s been kind of flatter on that funded number and the funded book-to-bill or your stated book-to-bill, it’s been decent but it’s seen higher numbers in the past, I guess. Are you expecting or should we be expecting that those numbers to improve through this year or does it take you a little more time to make any changes you’re making on the B&P side?

Tom Bell: Thanks for that. And yes, we’ve put the right team in place to execute the vision for us being a growing business profitably focused on profitable growth and so the pipeline is being refined to go after aggressively the right business, not all business. You remember one of my sayings, not all business is good business. And for Leidos, people understand that message and are priming the pump of the pipeline accordingly. We’ve got a healthy backlog, as you rightly call out. I’m not a big fan of these quarterly book-to-bill ratios because they are a fool’s mission. The right thing to do is focus on a healthy backlog of profitable growth. And we’re not embarrassed by the backlog we’ve got. It’s up 4% year-over-year and we’re looking to improve that as the year goes on.

We’ve got a huge pipeline of opportunities in front of us. All businesses have robust pipelines of good growth. And yeah, in the latter half of this year, there are a significant number of new and takeaway businesses that we’re hoping to brag about on future calls, but we’ve got to wait and see on those things.

Noah Poponak: Okay. Thanks very much.

Tom Bell: Sure thing.

Chris Cage: Thanks, Noah.

Operator: Thank you. One moment for our next question. Our next question comes from the line of Cai von Rumohr with TD Cowen. Your line is now open.

Cai von Rumohr: Terrific. Thank you very much. And Tom, good work on medical exams. Terrific numbers. So you mentioned that you’re approaching the ceiling on the medical exams. Can you tell us approximately when you might hit that ceiling? And can you give us any range of timeframe in terms of when we might expect a new RFP?

Chris Cage: Yeah, Cai, this is Chris. You know, again, the team’s done great work and we’re proud to serve our veterans. And it’s been volumes that the customer didn’t see coming when the original contracts were put in place. So it’s — the ceiling is structured differently. It’s based upon an exam volume and they’ve actually had to issue a justification authorization to extend that once already to give them time to run this competitive process. We believe that process should play out over the next couple of quarters and culminate by the end of government fiscal year if things stay on track. That’s the timeline we’re working towards. Obviously, it’s not entirely within our control, but our expectation is we’d have that new contractual vehicle in place beginning of our fourth quarter.

Tom Bell: Obviously, Cai, you’ll appreciate the fact that our nation can’t afford to gap this critical capability for those who have served us. And so we are very appreciative that the Veterans Administration is working with alacrity around the whole of the system and how they keep serving our veterans adequately. And we’re very much in dialogue with them to make sure that we’re positioned to make sure our veterans continue to be served.

Cai von Rumohr: Got it. And so you’ve done, folks, way better than most of the other services business. Is there any risk or thought that because you’re doing so well that the next bids might be structured so that there’s not the same profit opportunity because obviously, I would assume this has got to attract lots and lots of bidders or do you have any visibility at all or thoughts about how the VA might structure the next RFP?

Tom Bell: I think the long and short answer to that Cai is no, we don’t yet. They’re still working through that themselves. But we feel very confident in the investments we’ve made, in the facilitation that we’ve done, the technology we’ve deployed, the team we’ve assembled that we’re in a very good place to compete and continue to serve our nation, and the Veterans Administration. Exactly what the rules are and what the incentives are in the next RFP will be known in time. But whatever the customer decides to do, we’ll adjust accordingly and continue to work to make an adequate return on our investment and adequately serve our nation’s veterans. So we’re not deterred by this. We’re actually excited. The fact is we are making robust profits here because we’re serving our veterans so effectively.

We’re doing exactly what the Veterans Administration has incentivized us to do. And so it’s a good news story. And the veterans who get served, the quality of care they get coming into a Leidos QTC clinic is better than any. And the customer service and the customer reputation we have is best-in-class. So we’re very excited about it and very eager to continue to serve our nation in this way.

Cai von Rumohr: Terrific. Thanks again.

Chris Cage: Thank you.

Operator: Thank you. One moment for our next question. Our next question comes from the line of Robert Spingarn with Melius Research. Your line is now open.

Robert Spingarn: Hey, good morning.

Tom Bell: Hey, Rob.

Robert Spingarn: I hope you can hear me. I’m not — this isn’t a great connection. Can you hear me okay?

Tom Bell: Yeah.

Chris Cage: Good.

Robert Spingarn: Okay, good. So, Tom, I wanted to start with a big-picture question and it’s about AI. You talked about it earlier and this is a little bit more from the industry perspective but you and your competitors generate 60% or more of your sales from cost plus and time and materials contracts. And I’m wondering if the work of consultants can be automated or done more efficiently through AI. Might that presumably lead to lower costs and reduced billable hours? And in that case, how does the value accrue to shareholders rather than all of that efficiency just being passed back to the customer?

Tom Bell: Rob, what we’re looking at with AI, and I mentioned it in my prepared remarks, is really becoming that conduit from commercial best practices and Gen AI technologies into the government space. You’ll appreciate as well as anybody the fact that the government space and the government systems have a whole bunch of idiosyncrasies and complications that people like Leidos and Leidos in particular, know very well. So the two examples I cited in my prepared remarks of Sourcegraph and Moveworks are two examples of best-in-class commercial capabilities that we’re being able to use to generate outsized productive results for our customers. What that does is it does cut down work in the customer ecosystem, but it allows the people to go do more value added work than just the trite, routine, repetitive or deeply analytical things that then we team with a human.

We’re very focused on integrating those solutions into our trusted mission AI solutions. And then we’re very keen that we don’t deploy AI and forget. We are very focused on our AI solutions being in partnership with the human being, never alone and unafraid. Chris, anything you’d like to add?

Chris Cage: Well, Rob, it’s a good question. It’s a good insight. I think we take the view that you’ve got to play the long game here. I mean if we were worried about maximizing the dollar on the current book of cost-plus contracts, I think that’d be a little bit shortsighted. So recognizing that, to Tom’s point, we can deliver more mission outcome with the same budget and then set ourselves up to be incrementally more competitive on future opportunities. That’s what’s going to play well with our customers, and that’s what’s going to keep them coming back to Leidos. So we see this perpetuating our growth momentum as we continue to invest in this capability.

Robert Spingarn: Okay. And that’s a real interesting answer. And then, Chris, just not so much following on to that, but talking about cost plus, again, I think if we look at the other side of that, I think, around 40% of revenues are fixed price. So a pretty meaningful portion. I’m wondering, I want to ask you about stale backlog. If the backlog reflects that 40%. In other words, it’s similar to the revenue profile. Is there any portion of that has pre-inflation pricing where you’d get a natural lift in margins as that work rolls off over the next couple of years and things are repriced post-inflation or with inflation?

Chris Cage: Yeah, Rob. I get where you’re going with that. And I mean there’s — I’d say there’s pockets of that, but there’s not a pervasive opportunity or concern in our current backlog. I mean a lot of it as we priced our backlog on multiyear jobs, even if it’s fixed price, we built in some inflationary expectation. Some of that, for a period of time, inflation ran hot. But the teams have flexibility on how they execute for those outcomes. And so we’re also motivated to drive efficiencies in our process. And each new bid that we’re moving forward with, we’re evaluating them on their own merits and looking for opportunities to make sure they can generate an attractive return for our shareholders. So feel good about our backlog and feel good about our pipeline and where that helps support our margin objectives over time.

Robert Spingarn: Great. Thanks for the help.

Chris Cage: Thanks, Rob.

Stuart Davis: Operator, it looks like we only have time for one more question.

Operator: Thank you. Our final question comes from the line of Jason Gursky with Citi. Your line is now open.

Jason Gursky: Great. Good morning, everybody.

Tom Bell: Hey, Jason.

Jason Gursky: Hey, Tom, you mentioned during the quarter and then here again on the call today, the Munich Security Conference and the somber event that it was. I’m just curious from a demand perspective coming out of Europe, kind of what you at Leidos are seeing these days And how do you go about taking advantage of the demand signals that you’re seeing in Europe at this point, given where you operate on that side of the pond, so to speak? And what kinds of programs you might be chasing over there?

Tom Bell: Thank you, Jason. Yeah, it was a somber sobering affair. For those of you who haven’t picked up the magazine that they published at the beginning, the title of the conference was lose-lose question mark. So that gives you a sense of the tone earlier this year. And I don’t think that that has become any more joyful. They are all 201 increasing defense budgets robustly. So there is certainly top line growth happening in Europe. But more importantly than that, my personal hypothesis is that we’re going to see defense expenditures globally, morphed from hardware to more system solutions and effectors. I beg your pardon for those words, but systems, integrated solutions, and effectors, not so much the platform that launches the product, but the actual effector for defense.

And so Leidos is particularly well positioned to serve that market, not only because we’ve got a robust presence in Europe already anchored in the UK but throughout Europe. But also because as I look at that shift in spend, not only the increase in top line, but the shift to product services and solutions and effectors from products to solutions, services, and effectors. I see Leidos in the unique opportunity to help our customers prosecute those needs. I mentioned in AUKUS, what AUKUS Pillar 2 is all about, seamless information sharing, AI, autonomy, advanced cyber, hypersonics, electronic warfare. And I mentioned — I mean this reads like a catalog of Leidos capabilities and strengths. So I think we are uniquely positioned. The fact that the US is talking about lowering the ITAR hurdles between the US and the UK as a part of all of this allows us to position ourselves even more forcefully to serve our UK customers in ways we have been inhibited from doing before.

And I think that gives us a launching off point to talk to the Baltics around undersea capabilities to talk to all about integrated air defense capabilities, to talk to all about electronic warfare capabilities. It just gives us the launching point to have much more robust conversations than we’ve been able to have before. And again, our Commercial and International segments now all aligned to have all those customer touch points aggregated into one place, so we can more jointly connect them and prosecute them with a whole of Leidos approach. I just really think is an exciting time for Leidos. So early days. They’re still doing a little stormin and normin about those budgets and how they’re going to do it. But we are not going to be haughty and say it’s all got to be us.

We also are humble partners in these things. So we’re working to find out who we might want to partner with in Europe to prosecute these even better and work with national champions as a result. So it’s a very exciting opportunity, but early days yet.

Jason Gursky: Right. Okay. That’s great. Appreciate the color on that. And then just the last one on the pipeline that you have in front of you here domestically, maybe you could just talk about what you’re seeing from a competitive perspective here of late and just general trends on the competitive environment would be great. Thanks.

Tom Bell: Yeah. So we’re doing reasonably well in defending the work we have, our recompetes and on-contract growth is good and we are very happy with our performance there. The retooling in our business capture and growth areas is all about going after the big game and making sure we put ourselves in a position to robustly prosecute new opportunities for Leidos. I feel very good about the team we’ve got. I’ve got very — the pipeline is actually stoked with those kind of takeaway opportunities, and there’s many that are well over a billion. So we’re seeing ample opportunities for Leidos to differentiate itself and competition, and we’re seeing ample customer uptake on the kind of things that Leidos does best. Chris, anything you’d like to color?

Chris Cage: Yeah, Jason, just quickly, I mean, I’d say that certainly, best value or decisions are the trend we continue to see. And I’m not seeing any crazy Ivans and the competitive set is pretty well known and understood. We pay a lot of attention to that. Oftentimes, it just comes down to are you writing a compelling proposal, getting clarity of what your solution, and do you have the unparalleled customer understanding that you need to really hit the mark on the things that they’re looking for that might not have jumped out in the RFI. So we think we’re doing that well. We think we’re focused on adding talent and depth in our account management structure to continue to do that well, and we like where we’re positioned.

Jason Gursky: Perfect. Thanks, guys.

Tom Bell: Thanks, Jason.

Operator: Thank you. This concludes the Q&A portion. I’ll now turn the call back over to Stuart Davis for closing remarks.

Stuart Davis: Thank you, operator, 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.

Operator: And this concludes today’s conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.