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spk07: Greetings and welcome to the LIDA's fourth quarter fiscal year 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. Please note this event is being recorded. I would now like to turn the conference over to Stuart Davis of Investor Relations. Stuart, you may begin.
spk13: Thank you, Operator, and good morning, everyone. I'd like to welcome you to our fourth quarter and fiscal year 2023 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're using today. Turning to slide two of the presentation, today's discussion contains forward-looking statements based on the environment as we currently see it and, as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. As shown on slide three, we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is included in today's press release and presentation slides. With that, let me turn the call over to Tom Bell. We'll begin on slide four.
spk14: Thank you, Stuart, and good morning, everyone. It's good to be with you today to report another strong quarter for Leidos and to put a bow on a very successful 2023. I'll frame my part of our conversation today in three parts. First, our 2023 results. Second, the progress we've made towards building a brighter future. And third, what you can expect from us this year. First, in our fourth quarter, we delivered 8% revenue growth for record quarterly revenue just shy of $4 billion. EBITDA margin was an outstanding 11.4%. And we grew non-GAAP diluted EPS at 9% year over year. Operating cash was also well ahead of plan. This means we delivered full year results that were above the high end of the guidance we set last quarter. For the full year, revenue growth was 7%. Non-GAAP diluted EPS growth was 11%. And operating cash flow growth was 17%. Consistent with my previous commitment to you about disciplined cash management, we repurchased more than $200 million worth of shares in the fourth quarter of 2023. I continue to be very impressed by the people and sound business engine we have here at Leidos. And I believe our top and bottom line financial performance over the last three quarters of 2023 just begins to hint at our full potential. Even while affecting our recent organizational realignment, the team ran through the tape to deliver an impressive 2023. I want to thank my leadership team and our 47,000 people who made these results possible through their hard work and dedication to both Leidos and our customers' missions. This brings me to my second point, the progress we've made towards building a better future We're already working well in our new capability-focused organization and seeing the first fruits from these changes. For example, we're sharing best practices much better across digital modernization programs for greater efficiency and efficacy. In commercial and international, we're quickly redeveloping our growth playbook, especially internationally, which we'll use to extend several of our business lines outside the United States. And we're aggregating and better leveraging our robust engineering talent across our platform businesses within defense systems. As we go through this year, we'll see many more ways this new organizational structure unlocks value. Chris will describe a few of the tangible financial benefits of this realignment on which we already have line of sight. But the team and I are acting quickly on two additional critical components to building for our future, reinvigorating our business capture prowess and ensuring we remain the best employer of top talent in the market. On the business capture front, we finished the year with a solid book-to-bill ratio of 1.1 times. As we focus on building quality backlog over time, this gives us a healthy $37 billion backlog $8.8 billion of which is funded. Still, I believe Leidos has another gear in terms of business capture, and my new chief growth officer has stepped up to his new responsibilities in this regard with vigor. He shares my passion for winning, and we are committed to delivering industry-leading win rates and above-market organic growth. My chief technology officer is aggressively focusing our total IRAD expenditures in select areas to ensure we always have differentiated solutions for our customers. And my HR lead is undertaking an intense effort to rebuild our entire employee value proposition so we remain the best employer in the market for the best talent. Cindy Gruensfelder joins Leidos to lead our defense system sector. She brings extensive aerospace and defense leadership expertise and is excited to take this part of our portfolio to the next level. And Dan Antle will rejoin Leidos as General Counsel in April, so he will be able to hit the ground sprinting with us. As a result of these and other changes I've made, 75% of my ELT is now new, in new positions, or have newly enhanced and more focused areas of responsibilities. The momentum is building, having the right people in the right positions rightly aligned. Not only is this team rightly aligned to the jobs they now perform, but I've recommended and the board has approved fundamental changes to our incentive compensation plans. This means our incentives are much better aligned to our shareholders' and customers' interests. These changes are fully laid out in our upcoming proxy statement, but big picture, you'll see simpler metrics around revenue, profit, and cash with increased emphasis on margin while retaining a heavy focus on relative TSR performance. This brings me to my third point, expectations for 2024. Chris will provide specifics on our 2024 financial commitments in a few minutes. Notably, our guidance fulfills the three-year commitments that were articulated on our previous investor day. We've already exceeded the margin target that we set in 2021, and this level serves as a great foundation from which to grow in the future. Our three-year cash conversion results ought to be right at that 100% target, which is the right level of performance for our business. And we have clear line of sight to our three-year revenue growth target. While it is important to me that we meet our prior commitments to you, I expect us to do better going forward. Our financial performance should be at or near the top of the industry. And to bring this improved profitable growth trajectory to life, 2024 will include deep strategic analysis within Leidos. Let me summarize this strategy process for you. Each new sector president will bring forward a best in class three to five year growth and profitability plan for their markets in a today forward view. And our growth and technology organizations will work together to create a proprietary hypothesis of the future, a future back look at customer challenges and needs for 2033 and 2028. We'll synthesize these today forward and future back views to identify market gaps and growth opportunities. And choosing among them will enable us to crystallize our new North Star. This process is being engineered to position Leidos to lead the industry in revenue, profit, and cash growth. And we look forward to sharing our plan with you at our next full investor day, likely early next year. In the meantime, this year, we'll look forward to opportunities to showcase for you many of the differentiated technology solutions, what I call golden bolts, we already use and are creating to solve our customers' most vexing problems. Finally, you may have already noticed the launch of a new branding campaign for Leidos this year, Making Smart Smarter. While we've gained important name recognition over our first 10 years, this campaign is about capturing brand recognition for Leidos. As you can see in the example on slide five, making smart smarter is centered around our people, how they and the breakthrough technologies they create in a unique ecosystem with our partners and customers truly set Leidos apart from everyone else. With these three simple words, we'll tell the story of the collective intelligence that is uniquely Leidos. Our campaign will catapult understanding of what Leidos does differently and better than anyone else, and also serve as a beacon for present and future best of the best employees. In closing, with a growing promises made, promises kept culture at Leidos, We've put many of the commitments I've made to you over the past nine months in the done category. We've exceeded our 2023 financial commitments. We've enhanced our focus on cost controls and cash generation. We've taken down leverage substantially. We've allocated more capital to shareholders, and we've moved expeditiously to a leaner, more focused organizational structure. By delivering on our 2024 plan, we'll soon put our full 2022 to 2024 investor day commitments in the done category also. But we are far from done. We have a busy and productive year ahead of us at Leidos. We will continue to drive toward great full profitable growth, not just revenue growth. We will aggregate our efforts toward better customer outcomes and better business pursuits. And the new leadership team and I will be working every day to make Leidos not just successful, but awesome in every way for every stakeholder. With that, I'll turn the call over to Chris for more details on our 2023 results and our 2024 outlooks.
spk12: Chris? Thanks, Tom. And thanks to everyone for joining us today. Let me echo Tom and express my gratitude to the entire Leidos team for how we executed in 2023. On balance, 2023 was an excellent year, and our financial performance was well ahead of the pace we set for ourselves at the 2021 Investor Day. Turning to slide six, revenues for the quarter were 3.98 billion. Revenues came in stronger than expected as customers continued spending despite a continuing resolution, and Congress acted to avert a government shutdown. In each quarter of 23, each segment grew year over year. Adjusted EBITDA was 452 million for the fourth quarter for an adjusted EBITDA margin of 11.4%. Health sustained its excellent performance, and we saw good sequential improvement in the defense solutions and civil segments. With a keener focus on margins, we exceed our 2021 investor day target of 10.5% plus one year ahead of schedule. Non-GAAP net income was $276 million for the quarter and more than $1 billion for the year, which generated non-GAAP diluted EPS of $1.99 for the quarter and $7.30 for the year, increases of 9% and 11% respectively. This strong bottom line performance came despite a drag from non-operating drivers. The non-GAAP effective tax rate for the quarter came in at 25.2%. Net interest expense was a $2 million tailwind for the quarter based on debt pay down, but a $13 million headwind for the year given the higher interest rate environment. Taken together, tax rate and interest lowered non-GAAP diluted EPS by 13 cents for the quarter and 14 cents for the year. Now for an overview of our segment results and key drivers, beginning with the revenues on slide seven. With a lot to cover today, I'll focus on the quarterly figures, but you can also see the full year comparisons on the slides. Defense Solutions revenues were up 7%, driven primarily by digital modernization, especially NGIN, offensive hypersonics, and the Sentinel program. Civil revenues were up 2% compared to the prior year quarter. The primary growth driver in the quarter was infrastructure spending by the FAA. Health continued to be a standout performer. Quarterly revenues increased 17% year over year, ending the year north of 3 billion. Higher levels of medical examinations was a key driver, as well as expanding capabilities on DIMSOM, increasing group events on RHRP, growing our Social Security Administration work, and breaking into new customer spaces like ARPA-H. On the margin front, On slide eight, defense solutions showed consistently strong profitability growth. Non-GAAP operating margin was 9% for the quarter, up 40 basis points year over year. The increase in segment profitability was primarily attributable to improved program execution and disciplined cost management. Civil non-GAAP operating margin was 10.8% for the quarter, compared to 11.2% in the prior year quarter. which had a rich mix of security product sales. What's especially rewarding to see is sequential improvement in civil margins for three straight quarters. Health non-GAAP operating margin for the quarter was 19%, which was essentially unchanged sequentially after excluding the $14 million echo roll adjustment received in Q3. The 470 basis point increase in quarterly margin was primarily driven by increased volumes, greater efficiency, and better program execution in the medical examination business, all of which led to higher incentive awards. Turning now to cash flow in the balance sheet on slide nine. Operating cash flow for the quarter was $304 million, and free cash flow net of capital expenditures was $226 million. Net cash provided by operating activities benefited from strong collections and working capital management. Day sales outstanding for the quarter was 56, a one-day improvement from the third quarter of 2023, and a two-day improvement from the fourth quarter of fiscal year 2022. For the year, operating cash flow was just shy of $1.2 billion, and free cash flow was $958 million for a 95% conversion rate. Excluding the $260 million of one-time cash tax impacts, primarily from Section 174, free cash flow conversion would have been 121%. In the fourth quarter, we repurchased $202 million of shares and paid $51 million in dividends. As of quarter end, we had $777 million in cash and cash equivalents and $4.7 billion in debt. With a leverage ratio of 2.8 times gross debt to adjusted EBITDA, we are comfortably below our three times target. Our strong balance sheet gives us flexibility to return capital to shareholders, and we have 13 million shares remaining under our repurchase authorization. On to the forward outlook on slide 10. For 2024, we expect revenues between 15.7 and 16.1 billion. reflecting growth of 2 to 4% over fiscal year 2023. Customer demand remains strong for our products and solutions, and our programs are well insulated from significant budgetary risk. But we are erring on the side of caution given the realities of the current funding environment. The government is still operating under a continuing resolution. Although we believe Congress will likely pass a budget within the next month or so, we cannot rule out the possibility of a sequester and a year-long CR. We are also provisioning for a slight temporary revenue headwind as our business leaders shift their team's focus to higher reward opportunities for Leidos. We expect 2024 adjusted EBITDA margin to again be in the mid to high 10% range, above the target that we laid out at our October 21 investor day. We remain committed to long-term margin expansion. To begin the year, we are guiding to non-GAAP diluted earnings per share between $7.50 and $7.90 on the basis of 134 million shares outstanding. This is down an average of 4 million shares from fourth quarter levels based on Q4 repurchases accomplished and another 500 million of repurchases anticipated in 24. This level of repurchase activity still allows for significant flexibility for additional share repurchases and other responsible capital deployment. Assumed in the EPS guidance is an effective tax rate of 23% and net interest expense of 225 million. Finally, we expect another strong year of operating cash flow at approximately 1.1 billion. Fiscal year 2024 cash flow guidance reflects approximately $60 million of cash tax payments related to the Section 174. 2023 cash performance was exceptional, and we expect conversion to return to normative levels near 100% in 24. From a free cash flow perspective, we're targeting capital expenditures of approximately $190 million, or about 1.2% of revenues. With broad bipartisan support, the House passed a tax package that restores immediate expensing of R&D costs under Section 174, with retroactive effect to 2022. The bill has yet to be taken up by the Senate. Our guidance assumes the Section 174 cost capitalization rules remain in place, so we would have additional cash to deploy if the House bill becomes law. In 2024, we'll be operating our new segment structure. And to help your modeling, we recast 2022 and 2023 financials in the new structure and filed them with our press release. Let me spend a few minutes outlining these segments and how we see them performing in 2024. The largest, national security and digital, includes core defense and intel services, digital modernization for U.S. federal customers, and our Leidos Innovation Center. Flagship programs include NGIN, AGES, DES, and large cyber analysis and mission software development contracts with the intelligence community. 2023 revenues for this segment were $7.2 billion, up 7% year-over-year, with non-GAAP operating income margin of 10%. In 2024, we expect revenue growth within our guided range, with margins contracting slightly. we see margin upside with shared resources and best practices across the digital modernization space. The health and civil segment will deliver customer solutions with unique capabilities in the areas of public health, care coordination, life and environmental sciences, and transportation. Key programs include our disability exam work, DMSUM, national airspace system support for the FAA, in our DOE and National Science Foundation-based support contracts. Last year, health and civil generated $4.2 billion in revenues, up 7% year-over-year, with non-GAAP operating income margin 14.5%. In 2024, we expect robust growth beyond the corporate average with margins coming down slightly. This segment offers the most potential upside in 24 with growing examination volume. Commercial International combines our existing SES, commercial energy, UK, and Australian businesses. Last year, Commercial International generated $2.1 billion in revenues, up 12% year-over-year, with about five points of growth coming from the airborne solutions business acquisition and non-GAAP operating income margin of 7.8%. Based on actions taken in 2023 within SES, an indirect structure tailored to non-federal work, we expect margins to increase in 2024. Revenues, however, should be relatively stable and reflect a similar seasonal pattern to 2023. Finally, defense systems combines our core Dynetics work with our maritime and U.S.-sponsored airborne surveillance support. In 2023, defense systems accounted for 1.9 billion in revenues of 4% year-over-year, with non-GAAP operating income margin of 8.3%. With additional engineering discipline from the combined organization, we expect to increase margins through better program execution, but revenue should remain relatively flat compared to 2023. In the fourth quarter of 23, our customers accelerated hypersonics weapon testing, resulting in pull-through of work previously scheduled for the first and second quarters of 2024. As a result, the defense system segment revenues will be back-end loaded in 2024. So rolling up to the enterprise level, we expect bulk revenues and margin to step down from Q4 levels in Q1 and then grow throughout the year. The Q1 step-down in margins will outpace that of revenue, given the timing of incentive and award fee payments. but we have good line of sight into strong margin performance for the year. With that, operator, we're ready for some questions.
spk07: Thank you. We will now begin the question and answer session. As a reminder, to ask a question, you will need to press star 11 on your telephone and wait for your name to be announced. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star 11 again. At this time, we will pause momentarily to assemble our roster. Our first question comes from Jason Gursky with Citi. Your line is open.
spk02: Good morning, everybody. Thanks for taking the question. Just kind of curious about some of the assumptions that are going into the outlook. Two fronts. First would be kind of the assumptions that are embedded in your guidance related to the DOD budget, both in fiscal 24 and beyond, as you think about your medium-term targets, and just kind of the growth rate that you're assuming in the DOD's budget. And then secondly, just whether you have anything in your backlog today associated with some of the supplemental funding that has been passed here over the last several years? That's the first question there.
spk14: Thanks, Jason. Tom here. I'll go first and then ask Chris to chime in. Macro picture, as Chris articulated, are 24 guidances somewhat conservative given the funding uncertainties on Capitol Hill? So we're not leaning forward, assuming that there's growth in the defense budget this year. It all depends what Congress decides to do in the coming weeks and months. But longer term, sadly, the world is not becoming a safer place, and we don't see that customers are going to be spending less on national security and defense. So generally speaking, we see a 3% to 4% increase in defense budgets over time. But we're going to model all that as we go through this year of deep strategic analysis in 24 to make sure that our assumptions going from 25 to 28 are in keeping with what the budget assumption is from the Pentagon and other intel agencies in the U.S. Chris, anything you'd like to add?
spk12: Yeah, Jason, good to... to talk to you this morning and way to get us started trying to give us long-term guidance questions. But I would say on the second part of your question, relative to the supplemental, it's not an area that we've had very much exposure to at all. You know, some of the work that we've done there has actually been through our UK customer and a little bit of airborne support work. So that's not a, hasn't been a driver for us, and therefore it's not a risk as that particular funding stream potentially, you know, comes under some pressure going forward.
spk02: Okay, great. I'll leave that one so the others can get in and ask some questions. Thanks, gentlemen. Thank you, Jason.
spk07: One moment for our next question. Our next question comes from Ken Herbert with RBC Capital Markets. Your line is open.
spk00: Yay, good morning, Tom and Chris. How are you?
spk12: Good morning, Ken.
spk00: Hey, I just wanted to first start on the health segment, if we could, legacy health segment, I guess. I mean, it's been pretty significant outperformance as you've gone through 23, and it seems like each quarter it continues to be better than expected. Can you just maybe walk through, as you look at the guide for 24, I know obviously you've got now health and civil combined, but as you think about the health in particular, how does that continue to trend, and what's the visibility on continued strength, especially if you look at the examinations and everything else that have driven much of the upside.
spk14: Thanks, Ken. I'll start and then hand it over to Chris. We are so proud of Liz and the health team for their performance, their sustained performance that you call out over time. And it is important to recognize that that's a unique mix of unique customer understanding that we feel we have and then unparalleled service to our veterans and others that we serve through the deployment of technology and artificial intelligence in the solutions that allow us to have more throughput for our customers so that our customers can be served faster. Obviously, 13% revenue growth for the year is based on excellent program execution and profitability, and passing the $3 billion threshold for that business is huge, if you don't mind me saying. So we're very proud of Liz and the team macro, and we see that continuing in 24. Chris?
spk12: Yeah, Ken, just to add on a little bit, obviously the disability examination work has been a standout, but there's a lot more going on, as I mentioned in my prepared remarks, and really looking to extend our reach on some existing programs, and there's plenty more new programs in the pipeline the team's pursuing. So, you know, excited about the prospects there. As we said in our guidance, we'll continue the outperformance from a top line growth perspective heading into 24 on the margin front, a slight pullback. But that's really because we're continuing to invest. We're investing in our capabilities. We're investing to improve the workflow and the infrastructure to allow for that increased volume on the disability exam front. And, you know, really what's important about that is making sure the veterans get served. And we love to see those volumes increase. And clearly that's not a baseline assumption in our forward guidance that we see a higher level of activity there. But it's certainly a scenario that we have to be prepared for. And so we're making sure we're ready to step up to meet that demand if it happens.
spk00: Great. Thank you very much. I'll keep it there.
spk07: One moment for our next question. Our next question comes from Sheila Kaloglu with Jefferies. Your line is open.
spk05: Good morning, Tom and Chris. Thank you so much. Two questions, if you don't mind. Maybe one big picture and then one on the segment restructuring, resegmentation. So first on the resegmentation, national security seems like it mostly split off from defense. The margins in 23 are about 10%. And I think, Chris, you might have mentioned that there's opportunity for more margin expansion in that segment. Can you just talk about what you see there? Sure, Sheila.
spk12: Yeah, absolutely, Sheila. Thank you. So, you know, the national security and digital segment combines a couple pieces of our business, you know, one of which is our new digital modernization sector. That's the one that we see a lot of uplift over time. Steve Hull and the team are already highly energized around bringing together some commonality that we've been using to serve multiple customers and bringing those into repeatable solutions. We're often running there and really looking at how we get that leverage from a combined bench, a combined workforce, and best-in-class tools and repeatable solutions. So we see that opportunity. And then, of course, within the core national security work we do with our Intel customers, That has been exceptionally well run, and we continue to expect excellent program execution and performance and, you know, maximizing our opportunities with that client base as well. But the longer-term margin improvement that we see in the near term relates to, you know, the gains we can make in digital modernization space.
spk14: And just for clarity, the third part of that business is our link, our Leidos Innovation Center. And so while that has historically been homeroomed under our Dynetics subsidiary, we've pulled that up to the CTO level so that the innovation and entrepreneurial spirit that it deploys can be deployed for all the sectors and all the segments of Leidos. So that's the third part of that component, Sheila, just for clarity.
spk05: Okay, got it. And then, Tom, maybe a big picture for you, you talked about you know, incentive comp changes that'll come out in the proxy. And you highlighted profitability. I think I know why you did that. But where do you think profitability could go just given peers in this business are at the 11% mark at most?
spk14: Yeah, how high is high? We don't know, Sheila. And that's part of the enjoyment of 2024 and the challenge that we're giving each of the sector presidents to come forward with their sector best in class growth and profitability plan. Obviously, we're guiding to mid to high teens in 2024. Obviously, that is already at a pretty world-class level. Excuse me, high tens. Yeah, not teens. That would be... Someday, Tom. Someday. But mid to high tens. But in the fourth quarter, we hit 11.4%. So is cresting over 11 out of the range of possibilities some year in the future? I don't know. We'll see. But we're very focused on restoring bottom line growth as we increase top line growth. And as a result of both of them, it'll be a very accretive business from a cash standpoint.
spk12: Sheila, I'd only add on, obviously, again, as we gave you some color commentary on the new segments, There's a lot of gas in the tank that we see on defense systems and commercial international. They'll step up in margins in 24, but, you know, that could be a multi-year runway for those pieces of the business. And so, you know, we've been on this journey for a period of time now. Tom's come in and accelerated that journey, and I think we're seeing what the team's capable of. So excited about where the margins could go over time.
spk07: Great. Thank you. One moment for our next question. Our next question comes from Mariana Perez Mora with Bank of America. Your line is open.
spk08: Good morning, everyone. Good morning. I'll follow up on defense systems and commercial and international. So you think defense systems are going to be flat this year, but hypersonic should be something that, like, actually has a lot of upside opportunity. And I could imagine the same from the August deal in international. Could you please give us a sense of, like, how the CAGR should look like in a three- to five-year range from now?
spk14: So, I'm sorry, Mariana. I think you're asking about hypersonics and customer demand for hypersonics and then international. The hypersonics is a good news story, and as Chris alluded to in his comments, we saw a pull in to 23 of work we thought was going to be in the first half of 2024 of our customer demand signal for hypersonics. We're in deep dialogue with the customers about how we continue to accelerate that business because that is a capability that the United States needs to deploy robustly. So again, it's kind of like I answered Sheila. I don't know how high is high, but there is a very, very strong demand for the United States to field hypersonic capabilities that are in the world-class range. And obviously we are in a very good position to be a key component of those hypersonic systems going forward. So I think you're going to continue to see pull through there and focus. I think on the international side, one of the most exciting things we have going for us is the strong footprint we have organically and already, obviously, in the United States, but also in the UK and Australia. And there is great customer interest in what Leidos can do around AUKUS, not in Pillar 1. I have no interest in building nuclear submarines. but I really am interested in helping those customers in what they call pillar two and pillar three, which are in the Intel data and digital systems worlds. So very much in our wheelhouse for what we do here in the United States and in the UK and Australia, and very much a growth engine for us should be how we leverage AUKUS going forward. Chris, anything you'd like to add?
spk12: Well, one more point, Mariana, on back to defense systems. You know, we talked about hypersonics, but in addition to that, you know, the force protection work that we've talked about in the past, you know, the team has been working hard on the Ithic Enduring Program, and we're excited about the fact that we delivered some of the first fieldable prototype launchers in December. That'll transition into a phase here early in the year. But, you know, we're looking forward to a potential award in that particular area on LRIP and then full rate production later in the year. And that also is a growth catalyst that we see. So, when you start to look at that CAGR over a multi-year time horizon, you know, our expectations is those businesses will be accelerating. And Tom talked to a couple of the key points there that we see driving that activity.
spk08: Thanks so much. And if I may, more of a program-related question, do you have an update on how CHS 6 is trending and how much do you expect the program to contribute into 2024?
spk14: Yeah, Mariana, let me start, and then I'll hand it over to Chris also. Obviously, CHS 6, a major franchise win for Leidos in the fourth quarter of last year, one we're very proud of the team for. And it's a model that we expect to deploy going forward where we bring customers a value proposition that is compelling to them, both in the the delivery we can give them and the speed with which we can spool up to solve their problems. But, you know, one of the things that is not understood about CHS-6 is it's actually a very broad mandate for the customer. And it's not just IT, it's the whole C5 ISR domain. And so not only is it broad in what the customer can procure through CHS-6, but it's also a great platform example of how we can use the breadth and scale of Leidos to solve problems for customers. Not only is that homeroomed in one sector, but the Dynetics business is going to be a key part of helping it deliver for our customers. So we're very happy about that, and the basic catalog is being built out, and the orders are starting to come in, but Chris will give you some more details on that.
spk12: Yeah, just to add some color. revenue and profitability over the life of the contract. And a long contract like this does have a ramp up period. Tom's right. I mean, we're encouraged by the order activity, some long lead items that will actually contribute to revenue in 25 even, but we're rounding it out. The profile is going to depend greatly upon what those particular technical solutions, but we're leveraging our vendor network. We're leveraging AI. We've got a great team. There is some activity that we're not interested in low-margin work, so some of the pass-through will not show up as revenue for Leidos, but overall you can expect this to be an accretive margin program to Leidos overall and with a ramping revenue profile probably more later in the year.
spk08: Thank you so much.
spk07: One moment for our next question. Our next question comes from David Strauss with Barclays. Your line is open.
spk04: Hi, good morning. This is actually Josh Korn on for David. Hey, Josh. So, hi. I wanted to ask about the revenue guidance for next year. What you have is you just discussed CHS6 and ramping and some of the healthcare programs really strong. What are some of the, are there any offsets to get to, you know, the only 2% to 4% growth next year?
spk12: Yeah, David, let me start, and Tom can make some bigger-picturing comments. I mean, we've talked in the past about, you know, health has been great, but the DIMSOM program, as an example, you know, we're through the deployment phase, essentially. And so, even though we've won some additional work there with Digital First, there is a step down in volumes on that particular program. There was a national security intel program that transitioned away from us earlier last year, so that's a little bit of a headwind. So there's always some puts and takes in the portfolio. But more big picture, we're focused on there's some budget uncertainty. Customer demand has been very strong in Q3 and Q4, and that led to our outperformance. But as we look ahead to early parts of the year, a lot of the activity will need to transition into Q3 and Q4. So it all depends upon how quickly we can get some uncertainty in our budget environment and make sure customer demands remain robust. Tom, anything you'd add to that?
spk14: Well, I would just add, Josh, there's two macro headwinds that informed the conservative end of our range. One was the overperformance in 2023 that makes year-on-year comparators difficult, in this case challenging. We are very proud of our performance in 2023, but that creates a headwind for 24 year-on-year revenue growth against also the backdrop of the budget situation that is not yet crystal clear here in Washington, D.C. While the 2% provisions against the worst case scenario in that, we will be working with the team to meet or exceed the high end of that range as we prosecute the year. So you can be sure we won't be satisfied if we just hit the bottom end of that range. Great. Thank you.
spk06: One moment for our next question.
spk07: Our next question comes from Louie DePalma with William Blair. Your line is open.
spk03: Tom, Chris, and Stuart, good morning. Good morning. Tom, you discussed how you believe Leidos can increase its business capture. Does Leidos consider its Gremlins air vehicle a viable candidate for the emerging high-profile drone replicator program?
spk14: The Gremlin program was a fantastic demonstration of our prowess in aerospace. For those that don't know it, it was a remotely piloted vehicle that was also recaptured and then brought on board another manned aircraft. So a fantastic capability. But at this point, no, there's no discussions going on with the customers around that program going forward. although it has spawned other unmanned capabilities that we are talking to customers about that help inform possible growth aspects for our defense systems business.
spk03: Great. So is there a possibility that some of the Dynetics drone assets can be involved in Replicator?
spk14: There is certainly a possibility, yes.
spk03: Great, and I'll follow up on the international opportunity. You referenced how there is demand on the international front for the Leidos data and digital services. It would seem that allies have similar IT cloud networking and zero trust ambitions as the U.S., and you are obviously the largest provider of these types of megaprojects. And I was wondering, can you bring variants of IT megaprojects such as the Navy NGEN, the NASA AGES, and Enclave to allies? Or are there security restrictions as it relates to personnel? And are you focusing more on IT services or hardware as it relates to the international opportunity? Thanks.
spk14: Thanks, thanks Louie. Yes, so the beauty of pillar two of AUKUS is not only our presence in the US, the UK and Australia, but the fact that the work that is being done in those countries right now in the area that you reference is to a large degree already a place that we're playing in. So the beauty of AUKUS is an incentive for the nations to collaborate. We are very excited about the opportunities that gives us to lower the thresholds of sharing data. And obviously there's also big parts of the August legislation that lower those trade barriers lower the ITR restrictions and allow greater data sharing so. We see it as a open door for us to promulgate LIDO's capabilities that heretofore, Louis, kind of to your question, have been stovepiped in one country or the other across all those countries and allow these great allies to punch above their weight collectively.
spk03: Great. That's it for me. Thanks, everyone. Thanks, Louis. Thank you.
spk07: One moment for our next question. Our next question comes from Peter Arment with Baird. Your line is open.
spk01: Thanks. Good morning, Tom and Chris. Nice results. Hey, quick one on just maybe an update on DES and how that's kind of projected for the year. And then, Tom, just more of a bigger picture question on, you know, kind of capital deployment versus M&A. You've done and made a just tremendous amount of progress realigning M&A. the businesses and you've turned over, I think what you said, 75%, I think of your executive leadership team is either in new roles or has been replaced. Just how are you thinking? It's 24 more of a year where you're just going to continue to be internally focused on kind of showing the progress versus how do we think about that versus M&A and just regarding, you know, PIBACs as a preference. Thanks.
spk12: Yeah, Peter, it's Chris. Let me get started with a little bit of color on DES and then turn it to Tom. I mean, you know, again, this, this has been a, A longer growth story than we originally anticipated, but it's a nice one. The team is performing exceptionally well. We've actually extended from one task order now to five active task orders under the program. And, you know, it will be on a growth trajectory over still the next couple years. 24 will be stronger than 23 on both the top and bottom line. And we've seen good migration on the planning efforts. working closely with the customer and the DAFAs to, you know, get them ready for more migrations as we progress through 2024. So all I can tell you is it'll, you know, be a contributor to growth this year, not as significant as maybe once envisioned, but really looking forward to that growth rate continuing to accelerate later this year and into 2025.
spk14: And, Peter, I'm going to answer the punchline first and then give you some color. No, M&A is not a priority in 2024. It continues to be in the playbook, but subordinated to other deployments of cash. As Chris articulated in his prepared comments, we've already provisioned to repurchase $500 million worth of Leidos shares this year. I'm happy to share with you that that is not all the bullets in our ammunition. We have other ability to deploy cash for great ideas that start to come out of the strategy process that I spoke to. And we're very excited about bringing forward those ideas and deploying cash responsibly organically in great capabilities and great technologies that will enable us to have differentiated solutions going forward. Ultimately, the The five sector strategies that the presidents are building will not ignore M&A, but the primary focus first and foremost will be what are the gaps, what are the needs we see our customers needing, and how do we position Leidos best for those over time? Obviously, if we can build it, we have the funds and the capability to provision for that. But if it's better, faster, cheaper, and more expeditious for us to buy that, then M&A can come back into the playbook. But those will be a very thoughtful process through this year of strategy where we carefully think through the playbook for what inorganic plays make sense for the North Star strategy we're creating. I hope that helps, Peter. Very much so. Thanks, Tom. Appreciate it.
spk06: One moment for our next question.
spk07: Our next question comes from Noah Popenac with Goldman Sachs. Your line is open.
spk09: Hi, good morning, everyone. Hey, Noah. The civil margin, I guess, for the full year ended up flat year over year and not a ton of discussion in the prepared remarks here, I guess, despite the consternation there early in the year. You know, have we sounded the all clear? Maybe you could just spend a little more time on where you stand and stabilizing the challenges you've had there. And is the quarterly progression on the civil margin through 2024 a ramp up like the last two years or is it more stable?
spk12: Yeah, Noah. Hey, this is Chris. I'll get started and maybe Tom can talk big picture. So civil is obviously more than SES, but that kind of is implicit is where you're going. And I really applaud the team for great progress in 23 to right the ship and ultimately revenue and margins were in line with our expectations. You know, so the SES business itself is improving. We were higher on revenues year over year, but minimal contribution sequentially from product mix. So as we pivot into 24, you know, we'll expect the pattern to kind of not be as pronounced as in 23, but probably lower in the early part of the year, accelerating towards the back half of the year, how we see that rolling out right now. We're, you know, not all the way done, but we are, you know, well down the road on executing all of the turnaround efforts that we put in place. And some of the things where we're, you know, exiting certain geographies, you know, that's a thoughtful, carefully orchestrated process, right, that takes a sometimes many quarters to fully see it through. But I'd say, you know, we're in line with where we had hoped to be at this point in time. And I think the business is looking forward to better days ahead.
spk14: Yeah, I would echo that, Noah. And just give a quick shout out to Vicki, who has taken on the responsibilities for this sector with great vim and vigor. And the person leading SES, Mike Van Gelder, just a rock star for us at Leidos. And they are taking this reset business, and really they are excited about the opportunities that the market is presenting to us to grow, both in the traditional places and non-traditional places. So they and we remain bullish on the long-term outlook for this business, and we're excited to be in this aspect of the market.
spk09: Okay, great. And then just on health, you've sort of touched on this, but just the year-over-year comparison will be pretty different in the first half versus the back half next year. And then the exit rate on the margin is a lot different than where you started the year. Any color you can provide on the cadence of the growth rate and the margin through the quarters of the year, not to ask, you know, don't like to ask quarterly questions, but just seems like, uh, we could all be kind of thrown off on versus what, versus what you're expecting there.
spk12: Yeah. I mean, no, it's, um, it's a little nuanced there and, you know, again, without too many specifics, just keep in mind in Q3, we did have a, A request for equitable adjustment that contributed some uplift in profitability in Q4. We benefited from, you know, nice incentive performance. I think our commentary in the past, and it still holds true, is, you know, the customer is expecting industry to continue to step up volumes to meet the increased demand, and therefore the The threshold on throughput continues to rise to achieve full incentives. So, you know, early in the year, our expectation is, you know, we'll have some work to do to be ready to be able to prosecute that level of demand to earn full incentives. So, therefore, it's probably safer to assume, you know, that pattern will improve as the year progresses forward. The main point is, you know, investing to make sure the veterans get treated and seen and get the care and the benefits they're entitled to, and we're looking forward to continue to make those investments to prosecute that work as timely as possible.
spk09: Okay. Thanks so much.
spk06: Thank you.
spk07: One moment for our next question. Our next question comes from Bert Subin with Stiefel. Your line is open.
spk10: Hey, good morning, Tom and Chris.
spk12: Hey, Bert. Hey, Bert.
spk10: Chris, if we think about the revenue growth for you in terms of hiring inflation, does 2% to 4% growth indicate you're carrying some additional costs just because inflation is going to be in that range and hiring is presumably positive? And then on, I guess, another sort of related question on the revenue side, as we think about outlays likely normalizing at some point soon, how do you capture that in that 2% to 4% gap?
spk12: Yeah, Bert, you know, obviously the inflationary environment has been As we progress into 24, our outlook in that regard is it's moderated down relative to where we were a year ago. So I'm not worried that we've got an imbalance between our top line and bottom line as it relates to inflationary impacts on the business. We've anticipated a robust merit. pool for our labor costs. And, you know, we understand how those will be passed along to certain customers under our cost reimbursable programs, but our pricing is, patterns have anticipated you know this inflationary environment now over the last you know couple years so as it relates to protecting the margin of the downside on inflation uh feel good about where we're positioned there obviously um you know on the outlay side you know there's always this lag right between the budget and the outlay and the timing that it's difficult to project Certainly, it's an area that we could see some things accelerate, you know, in the near term, depending upon how we get through March in the budget environment. But right now, I'd say that, you know, that's not a significant driver as far as any pent-up outlays that we're waiting to have happen to drive, you know, significant growth catalysts for us.
spk14: And I, if you don't mind, Bert, I'm going to piggyback on that to give some comments about our people. We ended the year with 47,000 employees, up about 3% year on year. But the most exciting thing about our whole HR system in 2023 was attrition at very good levels for our industry, low levels for our industry. And one of the reasons we do that is not only do we have a competitive structure in our compensation plan, but we also are investing in our talented employees with technical upskilling, which is being taken up by thousands of our employees who remain curious about things like AI and cyber and autonomy. And the technical upskilling we have allows us to hold on to those employees and upskill them in place because as you'll appreciate, it's one thing to pay for talent. It's a whole different ball of wax to have to constantly bring on new talent. So we're very excited about The attrition rates being low, the uptake in our technical upskilling being very high, and therefore that being a lever that we're using to manage our personnel costs.
spk10: Got it. Okay. Thanks, Tom and Chris. Just a follow-up on, you know, we've had a lot of questions on the VA side, and I guess I'm curious, Tom, as you've gone through sort of this review of the business, you know, how big do you want the clinical business to be? You know, clearly the VAMDs have been a pretty material driver of profitability upside. And I'd have to assume the ROIC profile is sort of on the higher end of the company. Are there other meaningful opportunities out there, like not maybe the VAMDs, but like RHRP and military family counseling and others in the backlog in the pipeline that you think, you know, could make clinical a bigger part of the business longer term?
spk14: Yeah, the short answer to that is yes, we do think there are opportunities for us to grow this business, and that is the very task that Liz and her team are undertaking. It's one thing to say, yes, there are opportunities. It's another thing to think, how do we prudently and purposefully execute a plan to grow that business in the lowest risk possible? That's very much what Liz and her team are focused on right now, and part of the process that we'll be reviewing through the year.
spk10: Great. Thank you for the comments.
spk13: Abigail, we're at the top of the hour, so we'll just take one more question.
spk07: Thank you. Our last question. We'll have one moment for our last question. Our last question comes from Matthew Akers with Wells Fargo. Your line is open.
spk15: Yeah. Hey, guys. Good morning. Thanks for squeezing me in. Tom, you alluded to some IRAD kind of targeted investments in the opening remarks. Can you elaborate on those at all, what capabilities you're going after?
spk14: Sure. There's actually two parts of that equation, Matthew. One of the things that we're focused very much on with our link being elevated to our CTO office is CRAD, so making sure that we get customer-focused IRAD, which has a two-prong benefit. A, it is doing the things that the customers need done, so that points you in the direction of what is the scratch they want to itch, but also it's funded work that we can, you know, co-invest in. So we're very focused on targeting CRAD in the areas of technology that are going to differentiate us going forward, and we're very much focused on matching our investment, our AIRAD in those focused areas also. Macro picture, obviously software, cyber, AI, maritime autonomy are four of the top things we're investing in. But again, as part of the strategy process, we're asking each sector to identify the golden bolts that will truly differentiate them over the coming three to five years, so as to give them solutions to the customer problems that are emerging over that same period of time. So we have an articulated playbook of focused IRAD, we have an articulated playbook of CRAD that we're going after, but we're also creating organically a pull from the businesses of what would you have me invest in that will differentiate my solutions and my capabilities to solve my customers' problems.
spk15: Great. Thanks for the call. And I guess one for Chris, on Section 174, can you just remind us how much you have you could potentially recover if that does get overturned?
spk12: Yeah, sure, Matt. And I mean, it's a nuanced situation. So, you know, there's some variables you got to think through. Obviously, you know, it looks like it may be retroactive. And so if that were to be the case, and if there is a path forward to recovery monies that were previously paid in the year, and then we have some state taxes that have to follow suit. If all that lines up, it could be north of $200 million of benefit to Leidos. There'd be a little bit of... modest uplift on the effective tax rate but net net it would be a you know great benefit to the company and add to that additional amount of capital we would have to consider how we deploy appropriately in the later part of the year so you know a little bit over 200 million plus not having to pay the 60 million that we've got teed up in 24 so goodness all around great thank you thank you
spk07: This concludes our question and answer session. I would now like to turn the conference back to Stuart Davis for any closing remarks.
spk13: Thank you, Abigail, for your assistance on this morning's call, and thank you all listening on the line today and this morning for your interest in Leidos. We look forward to updating you again soon. Have a great day.
spk07: Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.
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