Leidos Holdings, Inc.

Greetings. Welcome to the Leidos first quarter 2021 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. In the interest of time, and to allow as many as possible to ask questions, please limit yourself to one question at that time. You may return to the queue for additional questions as time allows. If anyone should require operator assistance during the conference, please press star zero from your telephone keypad. Please note, this conference is being recorded. I will now turn the call over to Peter Burrell with Investor Relations. Peter, you may begin.

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our first quarter 2021 earnings conference call. Joining me today are Roger Crone, our chairman and CEO, Jim Reagan, our chief financial officer, and other members of the Leidos management team. Today we will discuss our results for the quarter ending April 2, 2021. Roger will lead off the call with notable highlights from the quarter, as well as comments on the market environment and our company strategy. Jim will follow with a discussion of our financial performance and our guidance expectations. After these remarks from Roger and Jim, we'll open the call for your questions. 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, during the call, we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two was included in the press release that we issued this morning and is also available in the presentation slides. The press release and presentation, as well as the supplementary financial information file, are provided on the Investor Relations section of our website at ir.leidos.com. With that, I'll turn the call over to Roger Crum.

Thank you, Peter, and thank you all for joining us this morning for our first quarter 2021 earnings conference call. As we communicated in our press release this morning, I'm pleased to announce that Chris Cage will be Leidos's next chief financial officer later this year. Chris will succeed Jim Reagan, who has chosen to retire following a long and distinguished career In particular, the last six years as my good friend and business partner. I'll have a few remarks on this transition before I hand the call over to Jim. But first, let's jump into the quarter. First quarter results reflect the perseverance, focus, and tremendous execution of our employees and business partners. New quarterly record levels of revenue, non-GAAP EPS, and backlog were achieved and significant organic growth was delivered across all business segments. This early momentum favorably positions Leidos to deliver on our full year financial commitments. Revenues for the quarter were $3.3 billion up 14.7% from the prior year and up 9% organically. underscoring our accelerated recovery from last year's pandemic headwinds and the early ramp of new business wins. Adjusted EBITDA margin of 11.7% up 240 basis points compared to the prior year period reflects strong program performance and the resolution of the longstanding MSA legal matters. which together delivered 45% growth on non-GAAP EPS of $1.73 for the quarter. Net bookings of $3.8 billion resulted in a book-to-bill of 1.2 times and 1.3 times on a trailing 12-month basis. This increase, driven by success in both our solutions and health segments, established a record backlog of $32.6 billion for a 13th consecutive quarter, providing greater clarity and confidence in near-term revenue growth expectations. I will now touch on a few of the major wins we received in the quarter that underpin our growth and backlog. In the health segment, the company was awarded a new prime contract to provide non-medical counseling to military service members and their families through the Military and Family Life Counseling Program, known as MFLIC. This important work will be conducted at approximately 100 U.S. military installations or nearby civilian communities. We currently estimate revenues will be approximately $1 billion over the potential seven-year life of the program. This new award is especially timely with May being Mental Health Awareness Month. Military members and their families experience unique stresses. These include fears for the safety of the service member and feeling anxious or overwhelmed by deployment-related challenges and responsibilities. Nearly one in four active duty service members show signs of a mental health condition. children of service members are especially vulnerable. One-third of children with a deployed parent have psychological challenges such as depression, anxiety, and behavior disorders. Through our work on the MFLCC program, we provide confidential counseling to alleviate stresses and enhance military members and their families' ability to cope with these challenges. counselors aim to prevent the escalation of stress into harmful conditions. About a quarter of our employees are veterans, so this program is meaningful to us on many levels. Next, in the civil segment, The company was awarded a prime contract by U.S. Customs and Border Protection to provide multi-energy portal systems for non-intrusive inspection of commercial vehicles at land and sea ports of entry. Under the contract, Leidos will integrate, deploy, and train CBP staff to use its VACUS MEP with low energy backscatter and high energy transmission cargo inspection system. The multiple award IDIQ contract has a total value of $480 million and a five-year base period of performance and options up to 10 years if exercised. And in the defense solutions segment, the company was awarded a prime contract by the Naval Undersea Warfare Center to provide engineering, technical, and management services for the Naval Array Technical Support Center. Leidos will be responsible for production engineering, technical and logistics support of the U.S. Navy and foreign governments' towed array assets. This single award IDIQ contract has a total estimated value of $149 million. Finally, the company was awarded contracts valued at $822 million if all options are exercised by U.S. national security and intelligence clients. Though the specific nature of many of these contracts is classified, they all encompass mission-critical services that help to counter global threats and strengthen national security. turning now to several notable accomplishments and events that took place in the quarter. We closed the 1901 group acquisition in January, and as anticipated, the business is being levered across all of our business segments in both the performance of backlog programs and new program bids. The inclusion of 1901 Group's cloud-based solutions and fully integrated service delivery platform will enhance performance on our customers' important missions and continue to differentiate Leidos' value proposition across the defense, intelligence, civil, and health markets we serve. Furthermore, as we shared with you on the February call, the Gibbs and Cox acquisition is nearing completion with yesterday's expiration of the HSR waiting period. With that gate cleared, we now expect the deal to close later in this month. Also, I want to take a moment to highlight the ongoing significant progress with the DoD Healthcare Management Systems Modernization Program, otherwise known as DMSUM. The MHS Genesis electronic health record system is now 30% deployed and is currently live and operational at more than 42 military treatment facility commands across the country with nearly 41,000 active users. Notably, during this unprecedented global healthcare crisis, the system has provided advanced capabilities to support clinicians and providers including 24 by seven access to medical and dental records and effectively tracking COVID-19 cases and mass vaccinations. Since its initial award, the program has been expanded to include the United States Coast Guard and the National Guard and Reserve. We remain on schedule to deliver MHS Genesis by the end of calendar year 2023. Shifting to the macro environment, while we are still awaiting the release of the President's 2022 detailed budget request and subsequent multi-year defense projections, we are encouraged by last month's release of the high-level budget request. While the recommended defense funding level was in line with our expectations, Our innovative technology and strategic investments remain squarely aligned with the administration's prioritization of certain critical need areas, such as digital modernization, cybersecurity, autonomy, and hypersonics. Additionally, we are very pleased with the proposed 16% increase in non-defense discretionary funding. This proposed growth supports the value proposition of our diverse business portfolio, which extends beyond defense and intelligence into the federal health and civil markets, including ports, borders, and airport security. And while a continuing resolution in the fall is feeling like a near certainty, The typical annual disruptions may be muted given the no growth request for defense and the reality that under a CR, agencies generally continue to receive stopgap funding in line with prior year's appropriation levels. With nearly $6 trillion of congressionally approved relief and stimulus funding since the start of the pandemic and a pending $2 trillion infrastructure request, we believe there could be additional opportunities for Leidos, particularly in our civil segment. Areas of interest include airport and FAA upgrades, as well as civil agency research and development. However, we will need to see the final details when they become available to better understand what is truly addressable over the multi-year infrastructure plan. With regard to the administration's decision to withdraw all troops from Afghanistan by early September, Leidos has been directed to leave the region within the same timeline. We currently estimate the revenue impact to be less than 1% of our Defense Solutions segment's current year revenue. While program-level customer discussions are still evolving, our best estimates have been incorporated into the guidance that Jim will cover later in the call. As we recently marked the one-year milestone of this devastating pandemic at the end of Q1, I want to provide you with another update on our Leidos Relief Foundation and now it has been assisting Leidos employees who have been impacted by the virus. Since March of 2020, the fund has raised and distributed over $1.7 million through generous personal donations from employees, members of the executive team, and the board of directors, including company match contributions. With those funds, over 500 Leidos families who have suffered a COVID-19 hardship or loss of a loved one have received financial assistance. The ongoing generosity of our colleagues is inspiring and a constant reminder of our shared values, no matter the challenge. Finally, as I noted at the top of the call, I will close my prepared remarks with a few comments on the upcoming CFO transition here at Leidos. On behalf of our Board of Directors and management team, I want to thank Jim for his countless contributions to this company and wish him all the best in his planned retirement. Jim joined us six years ago and has been my steadfast advisor and business partner. Jim and his team has grown the business over 160%, built an investment-grade balance sheet, and delivered significant total shareholder return. While Jim's contributions were critical in strategic planning and M&A deal structuring for key transactions, Value creation takes place in successful business transformations and building and nurturing culture and talent. And that is where Jim made the biggest impact for our employees, our customers and our shareholders. Thank you, Jim. However, I will save my goodbye since you'll be continuing to be an advisor through year end. Meanwhile, I'm pleased to share that our Board of Directors has elected Chris Cage as our next Chief Financial Officer, effective July 5th of this year, the beginning of our third quarter. Chris is a great example of the talent development and succession planning process here at Leidos. Chris joined the company in 1999, and many of you have had a chance to interact with him over the last several years as he has held a series of financial leadership roles with increasing responsibility, most recently as our Chief Accounting Officer. His financial experience and deep understanding of our business has prepared him and therefore our company for continued success. Since it's May 4th, before I turn the call over to Jim, I just wanted to say may 4th be with you. I will now turn the call over to Jim Reagan for more details on our first quarter results and guidance.

Thank you, Roger, for those kind words, and thanks to everyone for joining us on the call today. Upon reflection, I've had a very fulfilling career, and these past six years here at Leidos have been truly special on account of all the passionate and brilliant people who work here. I deeply value the relationships that we've built and the accomplishments that we have achieved together. I have great confidence in Chris's ability to lead the finance organization, and I look forward to working with him on a seamless transition. With that, I'll start by providing an overview of our first quarter 2021 results, followed by an update to the 2021 guidance. We are pleased with our strong start and growth momentum through the first quarter of 2021. First quarter revenue grew 14.7% over the prior year quarter and 8.9% organically. The increase in revenue was driven by the Dynetics, SDNA, and 1901 group acquisitions, growth on our existing programs, and increased contribution from new programs. This solid start to the year aligns with our fourth quarter messaging and showcases our resilient program execution fundamentals with all segments delivering double-digit top-line growth. Adjusted EBITDA margins of 11.7% grew 240 basis points over the prior year quarter. The increase was driven by program performance, mix, and continued indirect cost management. as well as the benefit from the successful settlement of the MSA legal matter. Excluding the positive impact of this $26 million legal reserve adjustment, adjusted EBITDA margins would have been approximately 11%. First quarter non-GAAP diluted EPS of $1.73 grew 54 cents over the prior year quarter, driven by strong execution and organic growth, as well as the settlement of the MSA legal matter. Without the settlement, non-GAAP diluted EPS would have been $1.59, reflecting 34% growth year over year. Operating cash flows for the quarter were $239 million. Excluding the net proceeds from the accounts receivable monetization facility, operating cash flows would have been approximately $145 million. The decision to utilize the facility enabled us to buy back approximately $100 million of Lido stock on the open market during the quarter, which aligns with our long-term balanced capital allocation strategy, which consists of being appropriately levered and maintaining our investment grade rating and 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. Additionally, first quarter operating cash flow does not reflect any net cash benefit from the MSA settlement, which is expected to be realized in the second quarter. Bookings of $3.8 billion were strong across all segments, resulting in a 1.2 times consolidated book-to-bill and record ending backlog of $32.6 billion. This represents 15% growth in backlog from the first quarter of 2020. Now for an overview of our segment results. Defense Solutions revenue increased 14.8% over the year, year over year, and 9.2% organically. Driving this strong growth was the Dynetics acquisition, the diligent execution of new programs, such as the CBP traveler processing and vetting software system, and growth on existing programs. As a reminder, consistent with our policy, Dynetics revenue will now be included in our organic revenue calculation since we owned the business for a full year effective February 2021. Defense Solutions non-GAAP operating margins of 9.2% increased 240 basis points from the prior year period, reflecting strong program growth on certain contracts, reduced indirect expenditures, and the recovery of a previously reserved international receivable. Defense Solutions booked nearly $2 billion in net awards for the quarter, resulting in a book-to-bill of 1.0x and 1.3x on a trailing 12-month basis. In our civil segment, revenues grew 17.1% from the prior year quarter and 6.1% organically. This growth was driven by the SD&A acquisition and volume growth on our existing programs. Non-GAAP operating margins in the civil segment grew 110 basis points year over year, driven by the net benefit from the MSA legal reserve adjustment, partially offset by lower margins on certain programs. Civil recorded approximately $700 million in net bookings for the quarter, resulting in a 0.9 times book-to-bill and 1.1 times on a trailing 12-month basis. And finally, Turning to our health segment. Health segment revenues increased 11.5% over the prior year quarter on both a gross and organic basis. This growth was driven by increased volumes on existing programs, including the continued backlog burndown in our medical exam business and timing of wave deployments on the DIMSOM contract. Health segment non-GAAP operating margins were strong at 18.6%, an increase of 310 basis points over the prior year quarter, reflecting increased volume and growth on programs with our VA and DOD customers and reduced business investments on a commercial IT venture. We expect elevated levels of non-GAAP operating margin to continue through the first half of 2021 and return to normalized segment levels starting in the third quarter. The health segment booked over 1.2 billion net awards driven by the successful win of the military and family life counseling contract, which resulted in a book-to-bill of 2.1 times for the quarter and 1.6 on a trailing 12-month basis. Before I turn to guidance, I want to give you a quick update on the $7.7 billion Navy NGEN program. Transition and onboarding are going well, but due to the late fourth quarter resolution in the courts, the pace of the ramp was lighter than the first quarter. We expect the ramp to pick up considerably over the next two quarters, giving us confidence in the organic contribution in both this year and next, as outlined in last quarter's earnings call. Moving now to the remainder of the year, we are increasing our guidance for adjusted EBITDA margin, non-GAAP EPS, and operating cash flow to account for two distinct items, the settlement of the MSA legal matter and the reduced share account resulting from our share repurchase during the quarter. Our guidance does not reflect the announced acquisition of Gibbs and Cox. As we've done in the past, we will provide an update in our next quarterly earnings call after the deal has closed. Our guidance range for revenue remains unchanged. We expect to deliver between $13.7 billion and $14.1 billion of revenue for the year. We expect adjusted EBITDA margins for the year between 10.5% and 10.7%, a 20 basis point increase at the midpoint from the previous guidance. reflecting the benefit from the MSA legal matter. As a result of the $100 million share repurchase executed in the first quarter and the net gain from the MSA legal matter, we are increasing our non-GAAP EPS guidance by 20 cents to a range of $6.35 to $6.65 on the basis of 143 million shares outstanding. And finally, to account for the expected net proceeds from the MSA legal matter, we are increasing our operating cash flow guidance by $25 million to at or above $875 million for the year. This updated guidance assumes no full-year contribution from the accounts receivable monetization facility. And with that, I'll turn the call over to Rob so we can take some questions.

Thank you. At this time, we'll now be conducting a question and answer session. In the interest of time, to allow as many as possible to ask questions, we ask you to please limit yourself to one question. You may then return to the queue for additional questions as time allows. If you'd like to ask a question at this time, please press star 1 from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. And our first question comes from the line of Sheila Kaiglu with Jefferies. Please proceed with your question.

Thank you very much. Good morning, Roger and Jim. Congratulations on your retirement. Thank you.

Good morning, Sheila.

Good morning. Maybe just because you spent a few minutes on your prepared remarks talking about this, Roger, and obviously there's an acquisition this morning from one of your competitors, Can you talk about, you know, your health division? How do you expect revenue growth to kind of work through with DIMSOM 30% implemented at the moment or deployed? And just bigger picture in terms of the health market, how do you see it evolving, whether the growth or just competitive nature of it?

Well, let's see. On DIMSOM, you know, we'll be at our current revenue level or higher for another couple years. And Sheila, as you know, our health group has traditionally been our highest margin and our highest growth area. And it's not surprising to us that others have seen the market as attractive as we have. And the interesting thing about the health market is it's always been highly competitive. And whether it's one of our competitors getting into one of our traditional businesses, it's just changing the name of the competitor And it is very much a commercial world. And we see the Biden administration, maybe the human infrastructure bill, as it comes to pass, is continuing to increase the spend. And we think it raises the importance of agencies like CMS and Social Security. And that's going to attract maybe some new competitors and maybe some non-traditional competitors. which in our strategic view of the market, we have always expected. And we believe we are successful in that market because we offer a value-added service to our customers, and we are, if you will, sharpening our tools and getting ready for what we think will be a significant growth in the top line in the market overall.

Thank you.

Our next question is coming from the line of Robert Spingarn with Credit Suisse. Please proceed with your question.

Hi, good morning, and congrats, Jim. Best wishes ahead.

Thanks, Rob.

On the defense margins, they were sequentially up and above the level you'd achieved previously in any quarter last year. So I wanted to talk a little bit more about the drivers. You did touch on them. You talked about mix, et cetera. And just whether COVID-related margin pressure is easing there, and if you can quantify the impact of the international receivable there.

Yeah, just starting with the last one, think of the recovery on the international receivable as, you know, $2 million or $3 million or so. I think more fundamentally the business has performed well on an execution basis. Companies with portfolios of our size always have a program or two that are – not making their planned margins, but the execution of the defense group has been going pretty well, including the strong management of indirect cost, which has also been something that's provided them with a lift. Now, that said, you know, we do have an R&D budget that we underspent a bit in the fourth quarter, and we expect that the level of R&D spending to tick up a bit through the balance of the year. And that's important for our long-term strategic priorities that are going to grow the business at strong levels going forward. The last thing that I would say is that as we think about the margin in defense for the rest of the year, it's going to continue to be strong, but I don't think you should necessarily be thinking of the Q1 level as being something you'll see every quarter for the rest of the year.

Jim, is that the case in all the segments? You touched on this earlier, that the second half is just a little bit lighter because the first quarter or first half was elevated. Is that all three segments?

Well, you know, in health, we've got the backlog burndown that we talked about that, you know, because of the way the operating leverage in that segment works, the margins are going to be a little higher than normal through the second quarter of the year. Those margins will tamp down a bit in the back end. But, you know, You know, unless we find that, you know, health care costs are lower than we expect, and if we find that, you know, our ability to generate proposals is more efficient somehow than we're currently modeling, I think that you can expect the margins to be a little bit lower in the back end of the year. And that is across the board, yes. Yeah.

Thank you very much.

Sure.

Our next question is from the line of Kaivon Rumer with Cowan. Please receive your question.

Thank you very much. So could you comment a little bit on the burn off of the backlog of the medical exams and the health area and what that means going forward? And then somewhat relatedly, Roger, you talked of the 16% increase in the FY22 fed civil budget. Talk about the opportunities you see there. Thanks so much.

Let me start with the backlog. So just for everyone on the line, we do medical exams for those people who are looking for a disability benefit. Our largest customer is the VA, but we do them across the board. And during COVID-19, There was a period of time we were shut down and a period of time that our efficiency was diminished because of social distancing. And so there is an inventory or backlog of people who want these exams. And it grew pretty much through last year to really for us an all-time high. Our commitment has been to work literally nights and weekends to overstaff our clinics to work off the backlog of And we're benefiting in this quarter by that, although we did have some weather in Texas and other states that tamped our quarter down just a little bit. But we think it will take us into the third quarter before we get back to a normal run rate. And that's our best estimate today, Kai. And we look at that. Well, the team looks at it every day. I look at it. Jim and I look at it on a weekly basis. We look at it by region and by type of exam. But we're making good progress today. The backlog is significant, and we think it's probably going to affect third quarter as well. And this is all positive, by the way, as it was severely negative a year ago. And we talked through that a year ago. As we think about the increase in the budget, and about all we know at this point, Kai, is what agencies look like they're getting the increase. And we're all you know, waiting for the PB to come out. But it does look like these are agencies for which we have a significant presence and significant heritage contract. So it's, you know, it's civil infrastructure. It's also some health. I mentioned in my prepared remarks there's going to be ports and borders and airports, FAA infrastructure. Those seem to be prime. There's probably going to be some roads and bridges, which is not really all that relevant to us. We think there may be some smart cities, smart highways, and we do have some contracts with the Department of Transportation, so we may benefit there. But the details are yet to be revealed, and when we're on the call next quarter, we will have the budget and we'll be able to address those better then. But thanks for your question, Kai.

Thank you.

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

Hey, good morning.

Good morning, Gavin.

Congrats to both Jim and Chris.

Thank you.

I wanted to follow up just a bit on Kai's question there. That 16% initial request number, often that gets revised, but it does seem like there's more appetite in D.C. for raising non-defense budgets maybe than there had been the last few years. So I'd just love to hear your thoughts on, you know, kind of whether that growth rate in the mid-teens or even double digits is actually realistic and what the request message is for the multi-year offensive budget outlook.

Yeah, you know, Gavin, it's really hard to handicap the, you know, the most watched sport in the national capital region, which is our political process. I think they're going to go to conference. I don't think they're going to try reconciliation, but they could. And if Senator Manchin from West Virginia has some influence, I think they'll come down a little bit and defense may go up. There are some politicians that we talk to who say, assume it's sequester and it's a tit for tat. So if you're going to take civil up, you have to take defense up. I don't think that's exactly where we're going to land. I think we're probably going to have a higher growth number on civil than defense. And, by the way, the defense number, depending upon whether you call it 704 or 715 or 753, does include the pay raise and now OCO in the base budget. So if you look at it from that standpoint, the overall, you could say, has some downward pressure. The areas that we compete in, we view as just generally flat. We are, though, I think when the dust settles and we get through the CR and we get a bill, are expecting maybe a high single, low double-digit increase on the civil side, and that's going to benefit our health and our civil group. And we've already, as you would expect, put teams together to try to anticipate where those funds are going to be spent and to make sure that we're doing the prep work to get ready to provide customers value on programs that they're going to come forward with. We actually think cybersecurity is a good area for us. We think DHS is what's called the CISA, which is their cybersecurity office, which tends to deal with cybersecurity in the dot-com space. We expect them both to get money in the base bill and money in the infrastructure bill. So cybersecurity overall looks like a good place to be. Thanks, Kevin.

Our next question is from the line of Toby Summer with Truist Securities. Pleased to see you with your question.

Thank you. Over the last handful of years or so, customers have been a little bit more willing to contract using different methods that end up being more profitable for service providers. What's your expectation for sort of a flattening of the defense budget's meaning for the ability of that trend to continue and yield, you know, good profit margins for the space.

Yeah, you know, Toby, let me see if I can address your comment that I'll let Jim add, is we tend to perform better when the contract is either fixed price or time and materials, where, frankly, the risk of performance is on us. And then we can invest and we can put in RPAs or something to drive more efficiency in the contract. With something we call a cost-based contract, we're kind of limited on the earnings potential based upon the fee that we bid on the contract. And with fixed price, again, we are almost immediately rewarded for technology and innovation on the contract. It's always hard to call trends, and I'm not sure we've seen, because not all of the officials have even been confirmed on the Biden administration. I wouldn't say that we have seen a trend away from TNM. When you started, I thought you were going to talk about OTAs, and I would simply say OTAs are alive and well, and I don't see that changing. Maybe this is wishful thinking. I would like to see the customers go to more fixed price, because I think It fixes their cost so they don't have to worry about year-over-year plus-ups, and it gives us performance responsibility and then the ability to earn more over the life of the program if we can drive efficiencies into the contract. I don't know, Jim, anything you want to add?

Yeah, just to pile on, that also delivers a benefit for the customer because when we have more latitude in how to deliver a solution as opposed to something that's prescribed in a cost-type contract, it allows us to help the customer save some money too.

And if you could just provide a little bit more commentary and color on the relative size of the opportunities within the infrastructure space. I think in your prepared remarks you mentioned airports as well as research. Thanks.

Yeah, let's see. I think it's too premature to give you a number. But, for instance, you know, when I said research, you know, we're safer, healthier, and more efficient through IT engineering and science. And a lot of people have forgotten about our science work. And so we run the National Cancer Lab for NCI as part of HHS. We also run the National Energy Lab up in Pittsburgh for the Department of Energy. And that's another great program. And we do essentially early stage, you know, 6-2 kind of R&D. And we expect certainly the Energy Lab in Pittsburgh, where in the last administration, we did a lot of work around coal and how we can burn coal cleaner and more efficient. We would expect this administration... will spend a lot of money on renewables. And we see the charter and the work in the National Energy Technology Lab really growing as we think about wind and solar and hydro. And so that will grow. And then there are a lot of other places. We do work on the Defense Threat Reduction Agency. And really across the board, we do some work for the Army up in Fort Detrick in the medical field. We don't talk a lot about it because, you know, there's not a big contract like, you know, maybe NextGen in our science work. But our heritage of doing early stage scientific work is alive and well. And, of course, as everyone knows, we were founded as the science application company. And so we still have a fair amount of business in that early stage work.

I appreciate that. Thanks.

Yeah.

Thanks, Toby. Next question is coming from the line of Joseph Denardi with CIFL. Pleased to see you with your question.

Thanks, good morning. Good morning. Roger, just on the SDA business, I think the expectation when you all bought it was that it would be about $500 million in sales and grow at 10%. It looks like you're running about $300 million now. Where do you expect that run rate to be by the end of this year? And then what are you all looking for on the infrastructure side to kind of give you clarity on what incremental opportunity that could provide for that business?

Let's see. We obviously don't guide by, you know, below. We don't guide by segment, much less by program. And so we're not going to do that now. We have said that the SDA business overall has been impacted by COVID and You know, there's less airport traffic, and so that's affected the business. And more so overseas, where funding is tied to ticket surcharges. So we're going to be below our business case when we bought the L3 business for this year. That being said, in the U.S., we continue to see strong activity by TSA and Customs and Border Patrol in buying equipment Because in the U.S., the purchasing dollars are really not tied to volume. They're tied to the federal budget. And as I said in my prepared remarks, we got an award on VACUS. We had gotten an award on rail at the border. We are bidding on upgrading, adding something called CT at the checkpoint. At major airports, we actually have a prototype in demo at Dulles. If you Come and visit us. You will likely, well, if you leave from here, you will go through RCT at the checkpoint scanner at Dulles Airport. And we would expect some of the infrastructure dollars out of the stimulus bill to be spent on ports and borders, maybe some on airports. And we're already looking at those opportunities. I'll also tell you that, you know, really country by country, you know, some countries are down. There are other country opportunities that have popped up that were not in our plan. So, you know, it's always a mixed bag. But if you were to walk away, you know, from the call, you know, I want everyone to know that the pandemic still has affected the SD&A business. And where we might have expected we'd be fully recovered at the end of this year or into next year, we think it's probably the end of 22, beginning of 23, before we're back to normal volume.

That's helpful. And then, Jim, a lot of focus on cash flow, obviously, last quarter. I'm wondering if you could just provide some perspective on the updated guidance for this year of 875. Is that a level of operating cash that you can grow off of?

in in 2022 uh if not what are some of the headwinds you face there thank you yeah i absolutely um the the change in the guide uh is is really as as i said in their prepared remarks the result of the expected cash coming in from the MSA settlement, we clearly believe that we should be moving back toward a conversion rate of about 100%. The headwinds for this year really are the reversal of all the tailwinds we had last year. And going forward into 2022, The only real change in conversion would be because of significant growth that will require the funding of working capital for receivables. And, you know, think of that as being roughly the net amount of that net of payables is about, you know, 27 days of sales is kind of the networking capital metric that we model based on.

Okay, so it would be that working capital plus the payroll tax, those would be the two primary headwinds in 22?

Yeah, that is right.

Okay. Thank you very much.

Sure. Our next question is from the line of Seth Seisman with J.P. Morgan. Pleased to see you with your question.

Thanks very much, and good morning, and congratulations, Jim. I wanted to ask about the civil segment, and so If we, you know, if we back out the legal settlement there, the profitability was a little bit lower than we're used to seeing and sort of what drove that and if you expected to kind of move back into that sort of low double digit range in Q2 that we saw last year.

Yes, Seth. Historically, the civil segment has had a little bit more volatility in its operating income margin number, primarily as a result of the timing of delivery of product out of the security products business, and this year will be no exception to that. We have some orders that are in the pipe that are being built probably in We'll see those ship in the second half of the year, and you can probably see volatility on the other end for that. That's what our forecast is telling us.

Great. I'll stick to one. Thanks very much.

All right.

Thank you, Seth. Next question is coming from the line of Mariana Persimora with Bank of America. Please proceed with your questions.

Good morning, everyone, and congratulations to Dean McRae.

Thank you very much. Good morning, Mariana.

So my question is on SDNA. Yesterday, Raytheon announced a contract award from the TSA to expand the deployment of checked baggage screening equipment to all federally managed airports nationwide. Can you please describe what was Lyda's role in that contract and also, like, discuss competitive dynamics on that business?

Yeah, Marianne, it's a great question. The contract that you're bringing up, we did not bid on it. That is a contract to support the maintenance of the checked baggage screening machines, and we chose to really pursue a path of bidding on the larger contract, which is checkpoint equipment of all kinds, whether it's screening machines or scanners. or trace detection equipment. And we were concerned that to try to bid both of them could compromise our ability to get the bigger prize, which is the one we're pursuing and should hear about it sometime this month.

And about competitive dynamics there, who are the main competitors and how has that over the last year?

Well, we currently hold what I think is the largest contract for the maintenance of the checkpoint screening equipment. And while the TSA has divided that up, you know, we have consistently gotten good performance ratings, and we think that we're well positioned to win a big piece of that work later this month.

Thank you.

Thank you. Our final question is coming from the line of David Strauss with Barclays. Please proceed with your questions.

Thanks. Good morning. I wanted to see if you could provide an update on Dynetics. You know, it looks like the revenue run rate there, just based on the disclosure around the acquired revenue, was a little bit lower. Is that just seasonality? And then anything you can say with regard to the lunar lander and the protest there? Thanks.

Well, let's see. I'll start off. I'll let Jim kind of catch you up on numbers. First of all, the Dynetics integration in the team is going really well. You know, their growth on a standalone basis is really eye-watering. And we've integrated our Leidos Innovation Center into Dynetics to better cross-fertilize our technology with their technology. And that has really created a lot of excitement. And we will see dividends of that in quarters to come. But the performance at Dynetics is really solid. And they continue to win programs in their relevant area. And our hypersonic glide body facility is up and running. It was down there two weeks ago, three weeks ago. It's gone classified. We actually have parts that we're building. And really, across the board, Dynetics is going well. I will give you a little bit of insight on HLS. I can't give you much. So there were three bidders, two of which everybody in the country knows, and us. And the contract was given to SpaceX. And upon our debrief and our review, we felt that things needed a closer look, and so we did file a protest. And I'm not going to disclose a lot of what's in our protest. There is some stuff out on the web. There was actually a good article written out of the Washington Post that I would refer you to, and I would also caution that the Washington Post is owned by by one of the companies that was a competitor. But I still thought that the article was very thoughtful and is a good basis of trying to understand what's going on in the HLS program. And because a protest is really sort of a, it's not quite a lawsuit, but it's certainly a dispute with a customer, I'd just rather not comment at length on our protest. But they typically last about 99 days. So in a couple months, we will see what comes out of the HLS program.

Yeah, and in terms of the numbers, you know, it's our policy that we don't include pro forma pre-acquisition revenues in calculating our growth rate. And so we didn't include the strong growth that Dynetics had on a standalone basis last year in our growth numbers. Now that we had it for a year, we are including it, and we do expect that as it is a part of the defense solution segment, we expect that to show some continued growth into 22, 23.

Hey, Jim, I think the question may be around, we break it out in page 14 of our calculation in the back, But after 12 months, we break it off. And so what you're seeing, what I see is the 83 number.

Yeah, the 83, that's a stub period. So you should not think of that as being the Q1 revenue from Dynetics. And so I think, David, what you might be seeing is just a partial period. And it might be misleading you to think that the revenue is down in Dynetics when, in fact, Dynetics is still continuing to perform well.

Yeah, what did we do, close at the end of January a year ago? Early February. Yeah.

Yeah, I was just comparing, you know, $83 million for one month versus kind of what your, you know, it had been your $300 million quarterly run rate the last couple quarters.

Yeah, I think that's just a little, it's just a timing thing.

Yeah, for sure. All right. Thanks very much. Okay. Thank you.

Thank you. At this time, I'll turn the floor back to Peter Burrell for closing remarks.

Great. Thank you, Rob, and thank you all for your time this morning and for 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.