Greetings. Welcome to Leidos’ Second Quarter 2023 Earnings Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note, this conference is being recorded. At this time, I’ll turn the conference over to Stuart Davis, from Investor Relations. Sir, you may now begin.

Thank you, and good morning, everyone. I'd like to welcome you to our second quarter 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'll use during today's call. Turning to Slide 2 of the presentation. Today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, includes risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. Finally, as shown on Slide 3, during the call, we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is included in today's press release and presentation slides. With that, I'll turn the call over to Tom Bell, who will begin on Slide 4.

Thank you, Stuart, and good morning, everyone. I'm pleased to be with you today leading Leidos into our exciting second decade. I'm also very happy to report that we closed a strong Q2. Driven by a healthy demand environment, we achieved revenue growth of 7% year-over-year, with strong organic growth across all segments. Margins, earnings, and cashflow rebounded from our first quarter, driven by, an improving business mix, a partial recovery in the security products business, and a series of fast-acting initiatives implemented across the business focused on costs and collections. Adjusted EBITDA margin of 10.9% was up 150 basis points from Q1, and non-GAAP diluted earnings per share of $1.80 was up 22% sequentially. Also, operating cashflow of $164 million was up $262 million from last quarter. While putting this quality quarter on the books speaks to the underlying strength of the business, even more important to me, it reflects ability of the Leidos team to focus and deliver when expectations are clear. Now, as this is my first quarterly call with you, I thought I'd share some of my initial observations of Leidos. Over these first months, I've met with customers, employees, and analysts, and I've conducted detailed operating and strategic reviews with all our business groups and each of our functional organizations. The headline from this work so far is clear, our business foundations are impressive. I've come to think of these foundations in three distinct pillars. One, an incredible team, two, compelling technology creation, and three, the ability to act with pace while leveraging scale. These three elements in combination enable us to uniquely solve our customers’ most vexing problems in differentiated ways. Let me unpack that a bit. First, we're a company of exceptionally talented and dedicated individuals. Their breadth and depth of expertise is remarkable, and they are palpably connected to our customers’ missions. That translates into a truly differentiated culture with deep customer insights. Also, the esprit de corps and genuine care for each other at Leidos, creates an environment that embraces collaboration and entrepreneurship, critical to our continuing success. Our ability to effectively attract and motivate top talent is a distinct competitive advantage for us. And in this regard, Forbes recently named us as one of the best employers for diversity for new graduates and for veterans, and Ethisphere recognized us as one of the world's most ethical companies for the sixth consecutive year. Second, technological innovation at Leidos is impressive, broad, and deep. The advances we are pursuing across Leidos are world-class. We leverage these key technology differentiators, what I refer to as golden bolts, across our entire portfolio. And we deploy these golden bolts in disciplines ranging from secure software to cybersecurity to signal processing, so as to bring extraordinary capabilities to our customers. A couple of recent examples of delivering complex mission capabilities to our customer includes, the successful hypersonic test launch under our MACH-TB program, and the last major deployment wave in the continental US of MHS Genesis, the Military Electronic Health Record System. This was done on time and on schedule, also significantly enhancing system capability. We've also been at the forefront of unlocking the power of artificial intelligence for our customers for decades. We've developed and deployed trusted AI to tackle some of our nation's most challenging missions. Our debut in applied AI was in 2004 when we built a self-driving vehicle as part of DARPA's Grand Challenge. By 2016, we launched the first unmanned autonomous ship. And now, we're deploying next-generation computer vision for automated passenger scanning in our ProVision 2 platform. Also, recently, we've deployed large language models in our Health group, designing a trusted AI solution where humans and AI work as partners to more rapidly align resources and improve our support to beneficiaries. Differentiated technology, including AI, created, unlocked, and responsibly controlled by our amazing people, is and will continue to be a unique attribute of Leidos. Now, to continue to accelerate our technical innovation, we are investing to broaden and deepen our workforce capabilities. So far this year, we've upskilled well over 3,000 of our people in fields ranging from AI to cyber, to software to digital engineering, and it's open to all our employees, not just our technical wizards, so that all can be conversant in our golden bolts. The third pillar I've found here is equally important, scale and agility. Every customer I've met with is feeling the stress about the pace of change. Hard, vexing problems are coming at them at speeds they've never experienced, and they're looking for partners with speed and scale to address these holistic problems. They need us to operate with a clock speed that matches their urgency. At Leidos, we lean into this environment by challenging ourselves to operate with a strong bias for velocity. For example, within the US Space Force, the Space Development Agency is focused on rapid delivery of space-based capabilities to the joint war fighter. This is an ideal fit for Leidos, an essential, technically challenging mission where standard procurement cycles aren't acceptable. To that end, today, our satellite payload remains the only Tranche 0 tracking layer asset in space, and we're on track to launch Tranche 1 assets soon that will serve as the foundation for the defense of our nation from hypersonic missiles. All these findings have strengthened my conviction in the potential of Leidos. However, also in my first months, I've identified some areas where we must improve. First, some recent acquisitions have fallen short of plan. While I believe those acquisitions offer us significant strategic benefits, we will redouble our efforts to achieve the value envisioned in our acquisition business cases. Second, all on this call recognize the fact that our financial performance has not always lived up to our investors' expectations. The team and I have had a series of candid conversations in this regard, and as a result, we have agreed that together when we make a commitment whether to each other, our customers or the Street, Leidos will meet that commitment. I call this simply a promises made, promises kept philosophy. Third, recent business development metrics have not been up to par. While we have a healthy backlog, currently $34 billion built over the last five years via a book-to-bill ratio of 1.3 times, we can and must do better. I believe that for a business like us, total backlog is a more relevant measure of future revenue growth than quarterly book-to-bill ratios. We will be determined to grow our total backlog over time with quality wins. As such, we'll be candid with ourselves about where we have a differentiated capability that the market recognizes and resource it appropriately. And where perhaps we find we do not enjoy true differentiation, we will ask ourselves some honest probing questions, courageously acting on their answers. Finally, I believe Leidos can benefit from a certain strategic sharpening. To propel this and to optimize our success going forward, we are now in the process of crafting a clear new north star for Leidos. As we crystallize this new north star, we will use it to guide all our strategic decisions, and over time, this will improve our win rates, drive margin enhancement, and better enable us to most successfully serve our customers’ most important needs. While this north star is currently a work in progress, I can give you a few initial indications of where we'll be going. We'll take steps to simplify our organizational structure to promote operational excellence, allow for faster decision-making, and more tightly align our business across our key technology differentiators. We will focus more on the bottom line via greater cost discipline and by refining our investment strategy toward those areas of best opportunity, best overall value to the enterprise. And we'll be very thoughtful and disciplined on capital allocation, both internally and externally. In the near term, I will be laser focused on improving execution, so I don't expect much in the way of additional inorganic growth, but after we complete our next strategic plan and reach our targeted leverage ratio, select M&A will likely make sense for us again. At that time though, we'll be crisp in our approach to ensure there is a clear opportunity to create value for Leidos and our investors. Lastly, I believe that a regular and predictable program to return capital to shareholders drives better investment decisions across any enterprise, so be looking forward to that as well. As we progress this work, I'll look forward to updating you on how we plan to accelerate growth here at Leidos, especially on earnings and cash. Now to our 2023 guidance. Based on our strong Q2 and our revenue momentum halfway through 2023, we are raising the top and bottom of our revenue guidance to a new range of $14.9 billion to $15.2 billion, an increase of $150 million at the midpoint. Revenue growth has been a key feature for Leidos in the recent past, and I'm pleased to acknowledge that this element of our business will continue to deliver for us. The delta in margin performance between the first 2Quarters of 2023 indicates to me variability in profit margin greater than that suggested by the prior 20 basis point guidance range Today, this is primarily due to the variability in our security products business. Now, the good news here is that the Civil team is aggressively knocking down these challenges by leaning out the cost structure and strengthening the supply chain. But considering the practicalities of a company becoming slightly more tied to product delivery timing, we are widening our adjusted EBITDA margin range guidance to 40 basis points. Therefore, our revised EBITDA range will be 10.1% to 10.5% for 2023. Lastly, we're reaffirming our non-GAAP diluted EPS range of $6.40 to $6.80, and we're reaffirming our operating cashflow target of at least $700 million. In closing, I'm optimistic about our future as we set course for Leidos’ second decade of growth, and I look forward to meeting with you at upcoming conferences and roadshows. With that, I'll turn the call over to Chris for more detail on our financial performance and updated outlook. Chris.

Thank you, Tom. Our second quarter financial results were indeed strong and put us on pace for a good year. Big picture, revenue continued its growth trajectory and we rebounded nicely on earnings. As I said on the last call, the Q1 profit shortfall was temporary, concentrated, and recoverable. We had improvement in the security products business, and we worked together as an enterprise to deliver solid results across the entire portfolio. Turning to Slide 5, revenues for the quarter were $3.84 billion, up 7% compared to the prior year quarter. Revenue growth was broad-based, as each of our three reporting segments grew at least 5% organically. Onto earnings, adjusted EBITDA was $420 million for the second quarter, which was up 15% year-over-year, and adjusted EBITDA margin of 10.9% increased 70 basis points year-over-year. Non-GAAP net income was $252 million, and non-GAAP diluted EPS was $1.80. Non-GAAP net income and diluted EPS were up 15% and 13%, respectively, compared to the second quarter of fiscal year 2022. Earnings growth came despite a $6 million drag from net interest expense. Both share count and the effective tax rate were essentially unchanged from last year. Non-GAAP profitability was up from Q1 levels in all three segments, driven by improved business mix and program execution, as well as enhanced focus on indirect spending across the company. Though there were some pickups from achieving milestones and truing up completed programs that won't necessarily recur in future quarters, we saw improvement along most key profit drivers. Specifically, EAC performance was strong, with net write-ups of $18 million, and SG&A as a percent of revenue showed improvement as well. The year-over-year numbers paint a positive picture, but the sequential improvement is even more encouraging. Total revenues were up 4%. Adjusted EBITDA margin was up 150 basis points and non-GAAP diluted EPS was up 22%. Turning to the segment drivers on Slide 6, Defense Solutions revenues increased 7% year-over-year. The largest growth catalysts were in the areas of digital modernization, including Navy NGEN and hypersonics, especially SDA Wide Field of View Tranche 1, as well as our Australian Airborne Solutions business. For the quarter, Defense Solutions non-GAAP operating income margin increased to 9.3%, up 100 basis points from the prior year quarter, with maturing development programs, strong execution, and lower indirect spending. Health revenues increased 9% over the prior year quarter, driven by growth on the SSA IT work, and increased demand for medical examinations. For VB A, we're seeing higher volumes from the PACT Act, and we're earning a higher work share as a result of our performance. Also, the Reserve Health Readiness Program is now building. Non-GAAP operating income margin came in at 17% compared to 19.8% in the prior year quarter. The decrease was primarily driven by the $28 million equitable adjustment in the second quarter of 2022 to cover costs incurred as a result of the COVID-19 pandemic. More important, Health non-GAAP operating income margin was up 110 basis points, sequentially bolstered by increased volume, solid program execution, and a positive outlook on incentive fee performance. Civil revenues increased 5% compared to the prior year quarter. The primary drivers of revenue growth were the NASA Aegis program, increased demand for engineering support to commercial energy companies, and a partial recovery within the security products portfolio. Civil non-GAAP operating income margin was 9.1% compared to 6.5% in the prior year quarter, which was unfavorably impacted by an adverse arbitration ruling in associated legal fees totaling $17 million. Sequentially, Civil non-GAAP margins improved by 270 basis points, which reflects partial improvement in the security products business. Consistent with expectations, the security products business is recovering but is not yet at peak levels. For perspective, year-to-date, the security products businesses actually up slightly year-over-year on revenue and down modestly on margin. As with last year, the back half of the year has the potential to be significantly stronger than the first half. We're seeing good traction in the business with the recent Leeds Airport award, and we've implemented the changes we talked about on the last call, including a leaner, more responsive cost structure and an improved supply chain. In addition, as part of the review of the business, we're looking at pruning the portfolio of products and geographies with lower returns. This work is ongoing. Taking a step back, we see security as an important and growing market, and we are positioning for success with our investment in the Charleston production facility, and looking to expand into new areas such as data center protection. Turning now to cashflow and the balance sheet on Slide 7, we generated $164 million of cashflow from operating activities, and $124 million of free cashflow. Net cash provided by operating activities benefited from strong collections and working capital management. DSO for the quarter was 59 days, a three-day improvement from the first quarter of 2023. We are in the middle of a cross-functional review of cash generation to include harmonizing vendor payment terms and building in more favorable collection terms on our contracts where possible. We continue to expect to drive sustainably improved performance over time. During the quarter, we paid the remaining $320 million of principal on the 364-day term loan agreement that came due in May, taking on $200 million of commercial paper to do so. These were the key movers of our $125 million net reduction in debt during the quarter. We expect to clear out the commercial paper during the third quarter, which will free up capital to deploy. On to the forward outlook. Tom gave you the revised ranges. Let me provide a little more color. We expect revenue to remain near Q2 levels in the back half of the year, with some degradation from the (Focus Fox) loss, and a move to a single wave of deployments on DHMSM by Q4. We have a large pipeline of opportunities pending decisions, and we aren't dependent upon significant new business wins to sustain our current revenues. On EBITDA, the expanded guidance range primarily reflects the range of outcomes on the security products business, as well as the volume of special project work, on fixed price contracts, and incentive fee determinations. We've made our best assessment of the likely outcomes and are comfortable that our wider range conservatively incorporates the reasonable potential results. With a narrower range on revenue, and a wider range on margin, we're comfortable with our EPS range, which also tracks well to our cash target for the year. As in prior years, cash generation is concentrated in Q3. With a strong Q2, we are ahead of our internal plan year-to-date. With that, I'll turn the call over to the operator so we can take some questions.

[Operator Instructions]. And our first question is from the line of Bert Subin, Stifel. Please proceed with your questions.

Hey, good morning and welcome, Tom. So, there was clearly a lot of concern coming out of 1Q earnings that weakness would persist in the securities product business. I mean, so far, that business seems to be recovering ahead of schedule. Can you just walk us through what changed in 2Q versus 1Q? What changes in the back half and whether you think SES can return to double-digit growth again next year?

Yes, thanks Bert. Well, first, before I turn it over to Chris to give some specificity on the latter part of your questions, let me say how proud I am of Jim and the team as they've been driving progress against that recovery plan. One of the first meetings I had with Jim was about the recovery plan and how we were going to get that ship righted. And as Chris said, the guidance that we've articulated incorporates the range of likely outcomes. The market is improving, as Chris suggested, with the Leeds award. We believe we have a superior product offering. We believe the customer continues to show confidence in our solutions, and the team is out there aggressively prosecuting the market. So, we feel very good about the fundamentals internally and the market externally. And also, the team is very focused on expanding the market that we serve with less traditional security solutions that are needed by a different set of customer sets. Chris, anything you'd like to add?

Yes. Well, I mean, Bert, obviously, there were a number of areas we were focused on driving improvements into, and the team has made great progress in that regard. I would tell you that we're not to the end game yet. Let me hit on a couple of areas. I mean, the customer-driven delays, that improved during the second quarter. We’re not back to the original plan, but we see a path. Again, that was one of the reasons why we put the guidance forward that we did today. In sourcing, you saw the announcement on Charleston. We're excited about that. The team went through a very thorough evaluation of alternatives, and we're full speed ahead to get that operational. We think it's a relatively modest investment with a longer-term payback. And then there were a lot of cost reduction actions that were taken. Those are never easy. As part of that, one of the things that we did do is revector a senior resource to focus on strategic supplier obsolescence parts management. We're seeing improvements in that regard, helping our supply chain in that relationship. So, pipeline remains strong. As we indicated, looking at areas outside of the conventional airport and ports and borders, and we'll be selective on how we prosecute those bids for maximum benefit to the bottom line and cashflow going forward.

Great. That's super helpful. Thanks. And just as a follow-up, Tom, so Leidos has been talking about a Dynetics inflection being on the horizon for a little while now, and previously the expectation was organic growth was going to ramp pretty materially in 2024 for that business. As you've come into Leidos over the last three months and got a greater assessment of sort of where things are going, can you just walk us through how you're thinking about Dynetics and what you see as the growth path there.

Sure, Bert. Well, my first trip as CEO was to Huntsville to visit with the Dynetics team down there, and I was just thrilled to see what we have there in Alabama. Great facilities, great people, and really importantly, great customer connectivity. Steve and the team down there are bringing focus to what defines them. They're always going to be a place, I hope, that the customers believe they can get stuff done cleverly and fast. I think that's a real dynamic for Dynetics. And at the same time, Steve and the team are refocusing their attention on three primary areas. They're really focused on differentiating themselves in the markets of small satellite payloads. So, the success I referred to with Tranche 0 and Tranche 1, tracking layer assets. That's them being focused on small satellite payloads. Hypersonics, the MACH-TB launch that I mentioned is one of our hypersonics pursuits. So, we think that's a key area where we can be differentiated in the market. And last, but not least, force protection and making sure that as our forces are out there, we have products and services that protect our forces when they're deployed. So, those are the three areas that we're focusing on while we maintain the agility and entrepreneurship that has always defined Dynetics. And with that, I'll kick it to Chris to see if he has any more color to add.

Bert, the only thing I'd add there is, I mean, Tom's right, our agility and expertise gets us in the door. Our frontend Leidos Innovation Center, we call it LInC, with some of the brightest minds in some of these areas in the world, have us access to the most important customer sets. So, we have to perform. That gets us in the door. The team has to perform and deliver, and that's what I'm most encouraged by seeing progress that they're making on having improved discipline on bidding and execution, improved supply chain management, all those things that are critical as we ramp some of these programs up towards low-rate production and full-rate production.

Thank you.

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

Yes, thanks. Good morning, Tom, and Chris. Hey, Tom, just to follow up on just kind of the products business in general. You kind of made some opening remarks on kind of improving the execution there. Just the variability in margins now because of the timing on product deliveries, just what's your view on just in general Leidos being in the products business? And do you expect to do more of this once you've kind of, I think you kind of said integrate and kind of improve the execution? Just your overall view on the product side?

Yes. Thanks for that, Peter. Yes, so I think having some diversity in our portfolio really makes sense for Leidos. I mean, after all, we're a $15 billion company, and in order to have countercyclical capabilities, you have to have some exposure, both to services and products. So, I like the fact that we're in a products business also. And I also like that there is connective tissue in everything we currently do that is poised in that thing I talk a lot about around how we solve our customers’ most vexing emerging problems. So, whether it be products or services or software, it's really focused on how we lean into our customers’ biggest challenge. I'm coming to understand our specific products and how they mix in with our services business models and how that makes sense. And at the core, whether it be a product or a service, remember that everything we do these days is at its core, IT services and algorithms and software and cyber, something that we are absolutely world class in. So, I like the mix and I think we'll be continuing the mix, and at the same time, we'll be very purposeful in how we exploit our advantages in each of those sides of the business.

Appreciate that. And then just, Chris, just quickly on the new EBITDA margin range, just puts and takes of what would make the difference between coming in and staying at the lower end or at the higher end? Is it all just tied to this aviation product deliveries? Are there any other factors that you would call out?

Yes, thanks, Peter. I mean, first of all, obviously the team here wants to deliver against the original commitment, but the wider range was prudent, given where we are and the volatility you'd seen in the first half of the year. But I’m very encouraged about the second half and very optimistic about how we'll progress from here. I would point to a couple of things. Security products is an element of that, and as I said in my prepared remarks, we have the potential to have a significantly stronger second half there. We've laid a lot of good groundwork to realize that. Not everything is within our control. On top of that, there are a couple other things. In Health, we had a great quarter in Health and the team has done an excellent job, and there is the opportunity to sustain that momentum as we move forward. But some of that is dependent upon not only our performance, but throughput and customer satisfaction, some variables on incentives that, again, we'll monitor closely, and our past performance suggests that those are fully attainable. So that's another variable that we wanted to give ourselves some capacity for because that incentive calculations is somewhat new. And then lastly, just some of our digital monetization programs continue to ramp up and we're very pleased with the performance the team has executed against there. And there are some opportunities for more project work in the back half of the year. And depending upon how and when that comes to pass, could push us towards the higher end of that range.

Appreciate it. Thanks, Chris.

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

Yes. Hey, guys, good morning, and welcome to Tom. I wanted to ask about defense margins, kind of the strongest margins here we've seen in a little bit. Could you just talk about sort of how sustainable that is as we get into the back half and into 2024?

Hey, thanks, Matt. Yes, obviously, we're super pleased with the performance there. 9.3% OI margin, the highest in five years, and a lot of that's led by progress we've seen on some of our big digital monetization programs. And the team's done an excellent job there with NGEN, and DES is continuing to ramp, and there are others. And there are some other things going on that are sustainable outside of that, maturing development programs. Tom talked about Wide Field of View, especially Tranche 1, incorporating the lessons learned from Tranche 0, better mix overall with the Australian airborne aviation business that we acquired last year. That's helping us. And then there are some variable items, and I wouldn't say these are totally one-off, but we need to continue to perform well to realize these in the future. Award fee scores were very strong. We reached certain program milestones, and we did close out some old older projects. So, we won't deliver 9.3 every quarter near term, but that's the expectation we're setting for ourselves and the team longer term. And so, one thing that we will not take our eye off the ball on is an underpinning focus on indirect cost management and program execution. So, yes, great progress in the Defense Solutions segment and we're optimistic that there's more of that ahead of us.

Okay, thanks. And then I wanted to ask about DES. We haven't talked a lot about it, just how you're thinking about the timing, and does that ramp up here as we get into 2024?

Yes, it's a great question. Very timely. In fact, we had a review internally with the team yesterday, and we've got a really strong team on DES and working hand in glove with the customer. This year, it's still a modest contributor to the company in the order of $50 million of revenue, but we just walked through a number of active task orders that are either in evaluation by the customer, or some other ones that were coming up for bid and evaluation later this year. So, we're seeing the activity level increase and there's a roadmap on migrations of more users under the DoD net. So, again, continue to think of that as something that will be a much more significant contributor in 2024 and 2025 really beyond that. And we'll have more to say as we get later in the year and have some clarity on when those get determined.

Great. Okay, thanks.

The next questions are from the line of Jason Gursky with Citigroup. Please proceed with your questions.

Yes, good morning. Tom, I was wondering if we might double-click for a minute on the comment that you made about leveraging acquisitions, maybe to better understand from your perspective kind of what went wrong, whether it was misalignment with expectations or execution, and what do you think it's going to take to fix what you've already acquired and what's going to change as you evaluate new acquisitions?

Yes, thanks for that. I wasn't here, so I can't say exactly what went “wrong.” I don't know that anything went wrong per se. I'm just looking at the current annual operating plan and the five-year plans for business against the original business case that was put forward to the board to approve the deals. And there's a certain gap. Now, I've been in this industry 40 years. I've frankly never seen an acquisition business case that doesn't have a gap. So, that's not new. That's not novel to Leidos, and that doesn't say that we've made mistakes in the past. That just means we've got the ball now and it's our job to make sure we leverage the investments we've made and the capital we've deployed to ensure that the real cores of the acquisition business case come to pass. That's with focus. That's with resolve. That's obviously by getting deep dives into program executions, and also making sure that we go back to the basics of the original business case and say, what is the golden bolt that we were trying to buy, and how do we make sure we deploy it across the enterprise as effectively as possible? So, that's what I'm focused on playing forward from here. As I suggested in my comments, I think the acquisitions that have been accomplished over the past 7, 8, 9 years here at Leidos, all make sense to me. Now, the key is just doubling down and making sure we make them make sense for our bottom line. Chris?

Yes. I mean, the one thing I'd add the playing off of Tom's words, the golden bolt example, I think our 1901 acquisition is a great example of that, right? And you don't hear us talking much about that because it's embedded into the organization and providing capability broadly against a number of our digital monetization contracts cutting across multiple sectors. That's the kind of leverage we want to see gained as we move forward with acquisitions. Dynetics, we talked about the Wide Field of View programs. And quite honestly, that is a combination of a legacy capability that Leidos brought to bear out of our Leidos Innovation Center. Dynetics is now in the midst of executing that program and building the payloads. That is the leverage we want to see going forward. So, we need to move more rapidly to link those capabilities together to get the full leverage out of future acquisition.

And on the subject of future acquisitions, you asked about what's going to be the drive going forward? As I suggested in my prepared remarks, obviously I think having a regular return of capital to investors makes sense to us. So, we're really focused on executing the work that we have on our plate now before we get back into the market to do M&A. However, when we do, in keeping with the north star that I referenced and a very clear articulation of where we want Leidos to be in 2030 - in 2028 and 2033, which are the two vistas we're setting out for ourselves, we'll have very clear articulations of, what are the technologies that we see emerging, what's the hypothesis of what the customer problems are going to be in the next five, 10 years, how might we either build those capabilities organically or acquire those capabilities inorganically. But all of those will be tempered with a very clear articulation of affordability, hurdle rates, and a very clear strategic narrative. So, premature to actually talk about what those are because we're still working out the north star and the vision of what our customers are going to need us to be, to serve them into the future. But those are the kind of things we'll be talking about.

Okay, great. And then as a quick follow-up here, your comments on backlog growth and kind of maybe not necessarily being where you'd like it to be at this point, can you talk a little bit about whether that is a market issue overall and kind of the dynamics going on with your bid and proposal activity and whether we're seeing either a slowing or acceleration? And then just kind of what you might want to change internally if it's not a market issue.

Yes. So, the good news is, I don't think there's a negative market dynamic we're dealing with here. There's positive demand across all of our customers and there's great opportunity for organic growth. As I suggested, we have a strong backlog. We have a strong pipeline, and I think the number is something like $26 billion in pending awards. So, the timing of those awards is unfortunate in that the first half of the year has been light. But again, as I referred to in my comments, I think quarterly book-to-bill ratios can become quite a distraction and are actually quite unhelpful. What I'm focused on is building a quality backlog over time with quality wins that speak to long-term growth for Leidos. And I don't think the BD process here is broken. I know we know how to win. I'm passionate about winning. The whole ELT is passionate about winning and I would not count us out just yet. Chris?

Yes, Jason, I would - Tom said his remarks that we need to be better. So, that does imply there were some things where we swung and missed on some opportunities, and we would've liked to have won those, but be rest assured the team dissects those backwards and forwards anytime we have a loss, right? And there's always lessons learned moving forward, and we're not going to win them all. So, there's that combination, coupled with there are some things that are out there pending, and we're optimistic that those decisions will come here in the second half of the year. Plus, the pipeline is strong, $135 billion. We expect to put another $20 billion of proposals through the back half of this year. So, very active, and again, our track record over the long haul has been strong. So, this is - there's not a fundamental breakdown in our process. We've got great people in our business development organization, but we do need to land some of these ones that we have out there for decision right now.

Great. Thank you, guys.

The next questions are from the line of Sheila Kahyaoglu with Jefferies. Please proceed with your questions.

Thank you. Good morning, Tom, and Stuart. So, Tom, first one for you, please, and I appreciate your comments in the opening remarks about margin enhancements. What are some of the steps on organizational structure and bottom-line financial discipline you plan to take? Because I was just under the impression that Leidos has pretty good margins, it just could be variable at times. So, where do you see the potential opportunities on the profit margin side outside of the security business?

I think there is - thanks for the question, Sheila. I think there is a slight reset in the culture that I've enjoyed putting out there, which is treating Leidos’ money as if it's our own. And as a result, Chris and I both talked about indirect spend and just tightening our belts a little bit and being a little bit more prudent with some of the indirect spend that is in any big bureaucratic organization. The reorganization I refer to is a tuning exercise. It's not a fundamental reset of Leidos. But I do think it will add to the bottom-line because as Leidos has grown dramatically over the last five years, we've bolted on and fit in some of those acquisitions such that there is replication and duplication of capabilities in different parts of our current value stream. And I think there is opportunity for us to bring those capabilities together, better bottle repeatability for customer solutions in some of those businesses, simplify the organization, promote better operational excellence around delivery for customer expectations, certainly speed up decision-making. And again, very key, align the organization around the key technology differentiators that set Leidos apart and define who we are in the markets that we serve. So, again, this isn't fundamental reset. It's a tuning exercise to take advantage of the inorganic plays that have been made, rationalize the organization toward those goals, and then incentivize teams to actually deliver against very crisp goals for those businesses. Chris, anything to add?

Yes, no, Sheila, I would echo that. I mean, clearly the primary objective here isn't to organize to drive costs out of the business. That'll be a second order variable. And we always try to run lean, so that'll create some opportunity to reinvest. We're hopeful, but back to your question, where are the margin opportunities? Obviously, super pleased with Health moving up a bit from what we had set as an expectation. You see what's possible within the Defense Solutions segment of the business. I think some of that will come down to selectivity. The teams will be more focused on which opportunities they have the ability to earn a quality return on. And so, we’re very optimistic that that'll pay dividends as we move into 2024 and beyond.

Great. And then Chris, one more specific one on Health. Yes, I thought the merchants were very good at 17%. I think you mentioned a new incentive calculation on the VBA work. Can you provide additional detail around how we might think about that opportunity going forward, and how do we think about the wind-down on the single wave at DHMSM impacting profitability in the second half?

Yes, thanks, Sheila. So, on the incentive side, again, this was a change that went into effect earlier this year. So, we're working through it and we'll have more to say as we learn more. But I would tell you that the incentive structure at the VBA was optimized from their point of view for all participants in order to better serve the veterans and to deliver better outcomes for VBA. And it gives contractors like Leidos the opportunity to invest, to drive quality outcomes, better throughput, better patient experience, and be recognized and compensated potentially for those outcomes. So, that's just getting started and that creates an opportunity where we're a bit more optimistic that if we perform the way we have in the past, and you have to earn it every quarter that the mid-teens margin has some upside to it that we previously communicated. And we'll just have to see how that goes. Obviously, the caseload volume from the PACT Act is still settling in. And the other thing that's settling in is us earning more than our fair share, if you will, of the work share, because our performance has been so strong. So, some of those variables will impact that as well. But we're optimistic that that should create some sustainable upside. And then on DHMSM, obviously this is a little bit of a headwind on the growth side, and we'll see a bit of a moderation in Q4 and more so in 2024. But from a margin perspective, I mean, it's a quality program, well run, but it is not one of the highest margin programs within the Health portfolio. So, I don't think that's a negative as it relates to Health margin. And the team is working hard and has a number of high-profile opportunities that they're pursuing right now that'll help offset the revenue piece as we move forward. And we talked about RHRP as another example of a program ramping that'll help offset that a little bit too. So, a few dynamics going on there, but don't look at DHMSM as a margin headwind for us.

Yes, and just not to let that go without my commentary too. I just want to say that we couldn't be more proud of Liz and the team there in Health because they are earning great margins because they have a differentiated offering that is serving our veterans and our customer in a differentiated way. So, it's really a joy to see that ecosystem come together.

Great. Thank you.

Our next question comes from the line of Seth Seifman with J.P. Morgan. Pleased to proceed with your questions.

Hey, thanks very much. Good morning and welcome, Tom. I just wanted to follow up. I think there was an earlier question asking about Dynetics and the inflection that was expected there next year. I wonder, maybe zooming out to the whole business, there are some standing three-year targets out there in terms of organic growth that would point to some acceleration in 2024. I guess, Tom, in the spirit of promises made, promises kept, should we should we still consider those targets to be operative?

Yes. Well, I'll start and let Chris fill in some blanks. I certainly am very aware of the Investor Day we held a couple of years back and the view toward 2024 that we gave at the time. I've started staring at 2024 lightly, but in all brutal honesty, Seth, I'm very focused on finishing 2023 strong and laying a strong foundation for Leidos over the next 3, 5, 10 years. So, I actually haven't done my own diagnostics of how achievable the 2024 targets are. But obviously, if we do hit the objectives in 2023, we're a step closer to achieving those objectives that we laid out in that industry day a couple of years ago. Chris, you want to?

Yes. Seth, the only thing I'd add, obviously, Tom coming on board, we've got to get him even more deep into our detailed plans as we look ahead to 2024. And one of the things that is a change condition is ensuring that we are optimizing for the best bottom line in cash performance and the selectivity that'll come with that. So, really being thoughtful around how our resources get allocated to pursue opportunities in technical investment and differentiation as we pivot into 2024. And some of those things will have near term paybacks and some of those things will have longer term paybacks. So, more to say on 2024 as we progress through the year, but everybody's heads down on delivering this year as strong as we can and putting some wins on the board and positioning for the future.

Great. Thanks. I'll stick to one this morning.

Our next questions are from the line of Robert Spingarn with Melius Research. Please proceed with your question.

Hey, good morning. Just following on that - hey, good morning, everybody, and welcome, Tom. On 2024, just with regard to the budget and the difference between the budget caps from the debt ceiling deal on the defense budget, and then on non-defense where there's going to be decreases, given that you have a couple of segments that point away from defense. Do you just broaden the aperture there so that your pipeline can offset potential pressure on the budget?

Yes, you're right, there is a curious dynamic that's been set up as a result of the debt ceiling debate and resolution that occurred, that obviously people on Capitol Hill are expressing optimism that they will solve before we're facing another government shutdown. At the same time, we're actively working with all of our customers on both sides of that equilibrium, if you will, to ensure that if there are things we can do this year to get them out of harm's way of any possible budget challenges they might face next year, we're engaged with them on that. And we're also focusing on exactly what you suggest, Robert, which is expanding the areas where we can help those customers and/or customers like them. So, I’m not overly concerned about 2024 and the law of unintended consequences, if you will. I'm very focused on the fact that the team is engaged with customers about all those eventualities, and we feel we're fairly insulated against near-term impacts from any possible government shutdown. Chris?

Yes, Rob, I mean, there's certainly areas within our Civil and Health business that we've been positioning to make sure we're in priority areas for our customers. We just talked a bit about the VBA side and that's not going to change. But outside of the civilian agencies, I mean, you look at what we do in our commercial energy business, and grid resiliency and critical infrastructure, and those are areas that you're going to see more spending dedicated to. So, the team's really been doing an excellent job there. And obviously, we've been talking a lot about security products in the pipeline and opportunities there. So, there are definitely parts of the portfolio that we will have strong budgetary environments, we believe, and we'll prioritize those in the near-term. And as Tom mentioned, we're optimistic that we'll weather any challenges in certain customer areas.

Chris, just on that last part, when we think about healthcare and discretionary versus non-discretionary funding, so Medicare, Medicaid and so on. Is there a way to quantify what portion of your healthcare business gets funded out of those non-discretionary budgets?

Well, a lot of the stuff that we're doing on the medical examination businesses is in that bucket, right? So, we know that's well protected and insulated. And then, obviously the health record modernization programs are priorities for our customer sets and what we're doing on Reserve Health Readiness. So, I think by and large, Rob, we’re in a good position there, but that'll be something we can come back with details on in the future.

Great. Thanks so much.

The next question is from the line of Toby Sommer with Truist Securities. Please proceed with your questions.

Hey, good morning. This is Jasper Bibb on for Toby. Just wanted to ask about the security products business and underperformance versus the acquisition case there. Would there be any way to quantify what getting that business back up to your targets might mean for Civil segment revenue growth and margins over the next few years?

Yes, Josh, I think it's a little premature. Obviously, we all know that with the COVID pandemic and worldwide aviation travel not where we thought it would be, that we're quite a bit under on the topline where that business was expected to be, but the growth rates over the last couple of years have been improved, and we're optimistic as we look ahead we'll continue to see that. So, when you look at Civil, I mean, what we're focused on is raising the floor of performance. Q1 was below our standards. Q2 much improved. Over time, we expect the Civil business to be on average a 10% plus margin business. And in the best quarters we'll see it 11% and above. And if we raise the floor of performance, which we're focused on in security products, that'll allow us to do that and achieve significant upside, hopefully over time. So, again, I think that just gives you a sense that there is room for that to grow going forward, and our job is to take out the variability that you've seen more recently

And on the top line and bottom-line expansion of our security business, as I have said, security is a vexing problem that's not going away. And in fact, more and more Civil customers, don't think government, civilian customers, are thinking about the security of their premises and the need for them to be more guarded on what goes in and what comes out. This is a great opportunity for market expansion for the team at very good margins. So, I like our bet on security, and I think it's going to be a good place for us to be as we prosecute the next five years.

Thanks for that. I’ll stick to just one question today so we can get some more people going.

Thanks, Josh. Hey, Rob, it looks like we're coming pretty close to the top of the hour, so I think we have time for one more question.

Sure. That question will come from the line of Noah Poponak with Goldman Sachs.

Hi, good morning, everyone. Chris, last quarter with security products, you provided a lot of detail on where the challenges were. You talked about customer schedule delays where they couldn't accept product, supply chain disruption, and then you said there were service agreement penalties and product investments. I was wondering if you could just quickly update each of those. I mean, how many customers are delayed and how many are on schedule? And then I guess those other three, are they just kind of fully behind you or not?

Yes. Hey, thanks, Noah. And I hit on this a little bit earlier on one of the questions, but just to reiterate, on the customer, it's predominantly a large program with a single customer that we've been - it's a multi-year arrangement to deliver a number of products. We are still not on the original schedule that we had laid out with them, and the team is working hard to get units accepted and progress was made in the second quarter. That will continue to be something we'll work through the third quarter and the fourth quarter this year. And again, with the guidance range we gave you, we're comfortable that if we're not able to get all the way back, we're still solidly in our range. So, that is ongoing, improving, but, but not resolved. The supply chain side of things, several things are going on there. Number one, setting up our capability to perform light manufacturing in the future. That commitment was made. We're full speed ahead on outfitting that Charleston facility, and we'll be well positioned beginning in 2024. In the meantime, we have improved our ability to get the component parts that we need. We've insourced certain circuit board repairs. We've seen OEMs step up with better response times. And as I mentioned, we've positioned one of our senior leaders in that organization to focus on critical supplier management and part obsolescence. So, again, that's shown improvements, which is not fully resolved, but significantly improved the service level penalty situation. I would say the R&D investments are on track. The team has laid out a plan. We're not compromising there. Ensuring that we have the full capability of our software with our hardware is critical as a differentiator for us. And so, we like where that is trending. And then we took out a lot of additional costs in the business to set ourselves up for more streamlined performance going forward. And I think that'll actually yield better communication flow, clear roles and responsibilities. And so, that'll - as we optimize that with the team that we have in place going forward, we think we'll see some continued improvements in our performance. So, solid progress. Not done, Noah, I think is the punchline, and that is an area that gets full visibility from Jim Moos, our Civil leader, and the whole security detection team, they're all over it.

Okay. I guess it's a pretty good step-up in the quarter sequentially, despite not being to the finish line on all of that. And I appreciate the widening of the margin range and the volatility that's inherent in what we're talking about here, but the guidance implies the margin is a decent amount lower in the back half, yet you're describing getting to the finish line on these Civil items. So, does the low end just incorporate the unlikely but can't rule it out risk that that customer delay takes a big step backwards? Or is there something outside of the tail that could get you to the low end of that margin range?

I’ll take that, if you don't mind, Noah. If I could characterize the widening of the range, that is in my mind more applicable for a business like ours that does products and services and is subject to the timing thereof. And so, I just think a 40-basis points guidance range is going to be the new normal going forward, but don't read into the 10.1 acquiescence or fatalism that that is the goal. It is certainly not the goal. The team is driving toward the high end, as you would expect the team to do. However, it is consistent with our promises made, promises kept philosophy where I don't want to put out a range that is - that later I'm not going to be able to hit. So, 10.1 to 10.5 is an adequate and realistic view of the entire range of possibilities we can see at this time, and we'll keep driving for the upper end of that range.

I understand. And if I might just quickly, Tom, appreciate all the color you've given here, and there's a lot of things you're talking about working on. You've had these questions on the financials of the business beyond 2023 and the prior Investor Day-oriented midterm, long-term outlook. How are you thinking about eventually having another Investor Day providing a fresh set of midterm financial goals versus not doing that and just running the business and letting the results speak for themselves?

The team is already talking to me about when we would have the next Investor Day. So, in my mind, it's a question of when, not if.

Okay. Thanks for taking my questions.

Thank you. This concludes our question-and-answer session. I would now like to turn the conference back to Stuart Davis for any closing remarks.

Thank you, Rob, for your assistance on the call this morning. And thank you all for your time this morning and your interest in Leidos. We look forward to updating you again soon. Have a great day.

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