Q3 2022 Leidos Holdings Inc Earnings Call
Greetings and welcome to the lightest quarters three 2022 earnings conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded its now my pleasure to introduce your host Stuart Davis Senior Vice President Investor Relations. Thank you Sir you may begin.
Thank you Maria and good morning, everyone I'd like to welcome you to our third quarter fiscal year 2022 earnings conference call joining.
Joining me today are Roger Krone, our chairman and CEO and Chris Cage, our Chief Financial Officer.
Today's call is being webcast on the Investor relations portion of our website, where you'll also find the earnings release and supplemental financial presentation slides that we'll use during today's call.
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.
Finally as shown on slide three.
During the call, we will 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 Roger Krone who'll begin on slide four.
Thank you Stuart and thank you all for joining us this morning.
Our third quarter results demonstrate the momentum in our business as we continue to report revenue growth at the upper end of our guidance across our diversified portfolio.
In addition, our dedicated team delivered earnings in excess of our forecast and generated the highest quarterly cash flow from operations.
History.
These results position us well to deliver on our full year financial targets as we make the world safer healthier and more efficient.
As usual I'll touch on our financial performance capital allocation.
Development performance and people.
First our financial performance for the quarter was strong and ahead of consensus at both the top and bottom lines.
Record revenue of 3.61 billion were up 4% year over year.
Adjusted EBITDA margin of 10, 3% was up 10 basis points sequentially and non-GAAP diluted EPS came in above our forecast and consensus.
Our third quarter performance and improved visibility enables us to raise our revenue outlook and Derisk our earnings for the full year.
We also generated a record $748 million of cash flow from operations.
This puts us on track to meet our cash commitment for the year strengthens our balance sheet and positions us for future capital deployments to benefit shareholders.
Which brings me to point number two our approach to capital allocation.
Yesterday, we closed our acquisition of Cobham Aviation services, Australia's Aviation Special Mission unit.
This business provides border force airborne surveillance and marine safety search and rescue and generates roughly 100 million U S in annual revenues.
Is immediately accretive to both non-GAAP EPS and EBITDA margin.
At this point in our strategic journey. The Cobham acquisition is a great example of what we're looking for.
It expands market access provides us franchise programs with a customer of strategic importance and complements our existing business.
All at a multiple below ours and a price that enables our shareholders to benefit from future revenue and cost synergies.
Our cost our cash balance at the end of the quarter was $807 million as collections were especially strong in the back half of September to close out the government fiscal year.
Our plan is not to accumulate cash.
We just paid for the Cobham acquisition, and we will be paying down some debt to move closer to our target leverage ratio of three times, our balance sheet enables us to steadily deploy capital in productive ways, given the strength of the company and evaluation that doesn't reflect our long.
History of driving steady earnings growth and cash generation will lean towards share repurchase when we have deployable capital.
Number three our business development results demonstrate that our strong positioning in the government technology market place is enabling us to navigate a difficult environment.
Procurement timelines continue to extend and D O T outlays, continuing to lag budget authority with net bookings of $4 1 billion in the quarter. We achieved a book to Bill ratio of 1.1 and grew backlog to 35 billion or 35 points.
4 billion on a constant currency basis.
We also had nearly a $1 billion of third quarter Awards protested.
Absence, the protests book to Bill would have been 1.4.
Highlighting some important awards, we received a five year $1.5 billion task order to support the D. O D with rapid technology insertion two enhanced C. Five ISR missions globally.
We expect to receive the full award value over the life of the contract, but in accordance with our policy, we only booked $100 million in the quarter.
This award notice Sentinel is all about getting capabilities into the theater and two the combat and commanders quickly.
And as a solution agnostic integrator part of our role is to find innovative technologies that can be rapidly matured proven and integrated in support of multi domain operations.
No fits within the joint all domain command and control our jazz <unk> umbrella.
Our positioning on Chad. She too was also bolstered by the Air Force's selection of the advanced Battle management system digital infrastructure consortium.
With four other consortium members lighters, we'll work to deliver the air Force's vision for distributed Battle management and decision, you're advantaged by enabling speed security and integration and scale.
[noise] NAV C Award in light of a $358 million contract to design and build a medium size unmanned undersea vehicle to provide autonomous oceanographic sensing and data collection for operational intelligence as well as to support mine countermeasures.
We also received our first task order on the 11.5 billion dollar defense enclave services contract.
138 million task order will lay the framework and begin to consolidate integrate and optimize five agencies on a common network architecture to digital modernization and transformation.
We successfully completed the transition period and have assumed operational responsibility for D O D net and dish.
And then a key win for our space business within Dianetics, we received a subcontract with Northrop Grumman to develop hypersonic defense sensors for the space Development Agency.
We have more than 40 years of experience developing and flying space based electro optical and infrared sensors and payloads for a variety of missions through this award will develop and build the sensor payload for proliferated constellation of low Earth or.
But satellites for the tranche one tracking layer there.
The tracking layer constellation will detect and track advanced hypersonic and ballistic missile threats as part of the S. T as missile defense architecture.
On the predecessor contract our tranche zero payload is on schedule to launch by the end of the year there.
So tranche, one design will increase coverage area, while reducing payload size weight and power.
Eventually these constellations of satellites will form the core of our new National Defense space architecture, providing global coverage and adding resiliency in the country's missile warning arena.
As a reminder, we'll be hosting an investor site visit at dynamics in Huntsville, Alabama on December 1st please reach out to Stuart if you're interested in attending.
And the final key win that I'll touch on this morning is the reward of our I T support to the social Security administration.
As of the second quarter call. Our award was protested by the previous incumbent and.
And after a resubmission of proposals the S. S. A real awarded all of the work to light us.
The incumbent once again protested the award and the New G E O review period expires on January 3rd.
And lastly point number four.
<unk> is an attractive destination for great talent.
In the third quarter, we have hired just over 2800 people and year to date, we've hired more than 9000 people and increased head count by more than 2000, it's still early but voluntary attrition is trending in the right direction and we don't expect that staffing.
Significantly constrained our plans for next year.
Our dedicated and capable people are a key differentiator for us and an important national asset.
Before turning it over to Chris Let me touch on the federal budget landscape.
As expected the federal government is operating under a continuing resolution at last year's funding levels until December 16th call.
<unk> is still working on the appropriations and authorization bills for government fiscal year 2023.
Nothing will get voted on until after the November eight elections, but we expect that robust budgets will get passed before the end of the calendar year.
Ladies are beginning to improve which bodes well for future growth Chris over to you.
Thanks, Roger and thanks to everyone for joining us today third quarter results were positive and in line with the picture that we gave on the second quarter call.
Turning to slide five revenues for the quarter were 3.61 billion up 4% compared to the prior year quarter. Despite a currency translation headwind of $32 million.
Adjusted EBITDA was 372 million for the third quarter for an adjusted EBITDA margin of 10, 3%, which was up 10 basis points sequentially.
non-GAAP net income was $221 million or $1.59 per share.
non-GAAP net income and diluted EPS were down, 15% and 12% respectively compared to the third quarter of fiscal year, 2021 which had the highest earnings in our history, driven primarily by the Covid catch up in the business let.
Let me touch on a few of the below the line drivers.
Interest expense increased to $50 million from 47 million in the third quarter of fiscal year 2021, with the rise in interest rates the weighted average diluted share count for the quarter was $138 million compared to $143 million in the prior year quarter driven by the ASR, we executed in the first half of.
The year.
Finally, the non-GAAP effective tax rate for the quarter was 25, 8% up 170 basis points sequentially, which reflected the cumulative catch up for changes to the mix of revenues across foreign and state jurisdictions.
The higher than expected tax rate lowered non-GAAP diluted EPS in the quarter by four cents.
Now for an overview of our segment results and key drivers on slide six defense solutions revenues increased by three 3% compared to the prior year quarter.
The largest growth drivers were the ramp on the engine and various force protection programs, which more than offset the end of our Afghanistan support contracts and the foreign exchange headwind.
Defense solutions non-GAAP operating margin for the quarter came in at eight 1%.
Civil revenues increased 10, 4% compared to the prior year quarter. The NASA Aegis program was the primary revenue driver, but we also saw good growth on our security products and commercial energy businesses.
The mix shift helped drive non-GAAP operating income margin to 11% up from nine 6% in the prior year quarter and the highest level in six quarters.
Health revenues decreased three 4% over the prior year quarter revenue in the year ago period benefited from the backlog of disability exams caused by COVID-19, and our share of certain exams has fallen with additional competitors added to one of our contracts.
These factors outweighed or another strong quarter on the dim sum program.
To this point, we have not seen much benefit from the Pact Act that was passed in the last quarter, although disability exam volumes remain high.
non-GAAP operating income margin came in at 15%, which is where we've been signaling all year.
Turning now to cash flow and the balance sheet on slide seven operating cash flow for the quarter was $748 million and free cash flow was 729 $21 million. These were record numbers for autos and I'm tremendously proud of the team's focus and dedication. In addition, the government customers were looking to clear the decks at the edge.
End of their fiscal year and in some cases paid invoices that would normally have been collected in Q4.
Dsos in the quarter came down three days sequentially to 58, which is our target level great effort by the entire team.
During the third quarter, we returned $53 million to shareholders, primarily through our ongoing dividend program.
At the end of the quarter, we had $807 million in cash and cash equivalents and 5 billion of debt.
We closed the Cobham Aviation Special mission acquisition earlier this week for 214 million U S. Inclusive of the hedge that we had taken at the signing of the definitive agreement.
In addition, we continue to focus on reducing our leverage ratio and we'll use some of our cash balances to repay part of the $1 billion of debt that matures in the first half of 2023 and reposition our balance sheet for the future.
[noise] onto 2022 guidance, our new ranges are shown on slide eight and you can see the outlook has improved from last quarter based on strong performance across the company.
The revised guidance includes two months of contribution from the special mission business acquisition as well.
We now expect 2022 revenues between 14.2 and $14 4 billion. So we've added $300 million to the bottom of the prior range and $100 million to the top end, even after absorbing an adverse impact of foreign exchange rates of about $70 million.
We're reaffirming our adjusted EBITDA margin guidance of 10.3 to 10, 5%, we still have work to do to get back into the margin range for the year, but I'm proud of how the entire company has responded to the margin pressures that we spoke of on last call. For example, we didnt decreased indirect spending and improved direct labor utilization across all three.
Segments. We're also taking a look at accelerating real estate reductions to drive out additional cost, which will improve our competitiveness and our margins going forward, we'll have more to report on that front on the Q4 call.
We're now guiding non-GAAP diluted earnings per share between $6 20, and $6 40. So we've taken 10 cents off the top and bottom of the prior ranges as I touched on earlier, our effective tax rate for the year is going to be a full point higher than we previously expected, which creates an eighth in headwind to EPS.
Compared to last quarter, our confidence around operating performance has improved.
Finally, we're keeping cash flow from operations guidance at a $1 billion or greater.
Obviously, we had a tremendous performance in Q3, which puts us on track for another strong cashier.
We continue to monitor the potential for Congress to act on the tax research cost capitalization rules with no change in law the cost capitalization provision amounts to a negative impact to operating cash flow of about $150 million annually.
We haven't made any federal tax payments related to the amortization of research costs. This year and do not plan to although we will continue to reevaluate as conditions change barring a legislative fix we expect to pay this $150 million in early January of 2023, and then make normal quarterly tax payments inclusive of this impact.
Thereafter.
With that I'll turn the call over to Rob. So we can take some questions.
Oh I'm sorry.
Maria we're ready to take some questions.
Thank you we will now be conducting a question and answer session.
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Our first question is from Gavin Parsons with Goldman Sachs. Please proceed with your question.
Hey, good morning, Hey, good morning, good morning Gavin.
Roger You mentioned, you don't expect staffing to significantly constrained you're twenty-three plan could you give us an early look at what that plan is in terms of revenue margins and maybe cash flow.
You know again, we are yeah, we don't guide.
Guide to twenty-three until the end of the year and so we're not kind of.
You know put out any numbers, what we will tell you though is that if you go back to our Investor day, and we put some longer term goals on Investor day, and we're still confident with.
The numbers, we provided you gosh I guess it was.
October a year ago, so, but we're still we're still very excited about what's going on in our space and we had a great quarter and we expect 'twenty three to be strong.
Okay I appreciate it that attract and then maybe in terms of defense you guys had talked a lot about the.
The investments, we're making there I wonder if you could tell us a little bit more about that and the expected payback periods will be great.
Well, maybe I'll start and then Chris can come back and we.
Especially in our.
Our our Michigan operations area find customers, who wanted to accelerate capability.
And look to the contractor base to make investments to get them capability into theater faster and the army has some airborne programs. In fact, I think our RFP just came came out a week ago and we.
We made some investments are ahead of that programming.
We hope.
To get a decision which will be next year.
And actually started the program next year. So some of these when we make an investment like that it's usually on a pretty short string so and.
It's very consistent with the airborne work that we already do and those.
Margins tend to be above our corporate average yeah, that's right and Gavin just to add to that Roger talked about the great win our space team had on the tranche one tracking layer and that's an example of where we've made some investments to ensure we could acquire the appropriate long lead items everybody's talking about supply chain constraints.
We've been monitoring that to make sure we got out ahead of.
The materials were needed to successfully.
Successfully win that contract as one example, and then to continue to invest in our capability in clean rooms engineering talent et cetera. So those.
Those are a few examples you know the dynamics. If you if you are able to make it down to the trip that Roger talked about that'll give you a firsthand view of some of the areas, where we've clearly made some investments in our facilities team and capabilities.
Great. Thank you great.
Great. Thank you.
Our next question comes from Rob Spingarn with Melius Research. Please proceed with your question.
Hi, Good morning, Hey, Good morning, Rob can you hear me.
Yes, Yeah, you sound, great Hi, there so that was good.
Roger when we talk to investors new to light as we often highlight your diverse segments and end markets and so in that vein I wanted to ask a longer term.
<unk> as you head into next year and beyond where you see the sales momentum.
The segments based on market interest in your products and services.
So essentially what I mean is that obviously, we're hopefully exiting a pandemic and rethinking how we handle our major medical crisis and you're in the health business. We're in the midst of a major infrastructure build here in the U S and you're in the civil business and of course, we have a rising defense budgets and a war in Europe . So how do you think long term.
About relative growth for each of the segments.
Oh, Rob Thanks for the question of course, we have been saying for years is we have been.
Portfolio shaping and positioning the company both in health Civil and defense to be in the swim lanes that are moving faster and so just as I reflect on all three of those are you know of course, our health business continues to have really really strong momentum, where we're almost through the COVID-19 catch up and back to normative levels.
But we see continued growth in our and our health business really driven by you know CMS social security.
And what's going on in D. A J and it's just been a great performer for us in civil we've talked now for quarters about the resurgence in air travel and we're seeing strong research and certainly in the U S. As I think all of us kind of a test and we're finally starting to see that.
Revenue passenger kilometers pick up internationally and our S. S team has had probably more meetings with customers in the last quarter than they did all of last year. So we're traveling again and that bodes well for increased orders, which will lead to increased sales in our global security business.
<unk>.
And then defense, which we actually you know if you're if you think about a year ago thought was probably going to be our lower growth business, but as we've all come to learn the world is a very complicated place and it continues to be very very complicated and I think those issues.
Meyer that both the U S and our allies continue to invest maybe more than they would otherwise like.
Slide two in our in the defense of of the Nations and so our defense business has really held up held up well and we don't see anything on the horizon. It changes our view of that future and you know I think it really speaks to some of the decisions we made to shape the portfolio and emphasize on that.
<unk> of the business that we did you know what I'll highlight one other thing we it's a smaller business for us and we don't often talk about it but within the civil group, we have in our commercial energy business.
And that has just been going going great. We do a lot of engineering for Investor owned utilities.
M L.
And energy savings programs for large production facilities and that business has been growing in double digits and the its interesting that utilities are connected to five G. Because you put five G on towers and you need engineering for that and that business has turned out to be a huge growth engine for us as well.
Chris you want to add yeah, So Rob I think Roger cover the landscape pretty well I would say that in the near term again or health business very proud of that business and the team and and we spoke about the SSA. This is a hard fought battle to make sure that we ultimately prevail through the protest feel confident that'll be a growth catalyst for us in 'twenty, three where we're quite sure of the our HRP.
Program that we've been talking about for a year finally, we're up and running on that so I really feel like the health business has room to grow in the near term and then the dynamics business is really you know 24 and beyond when you've got these force protection programs, you've got space you've got.
Things that can really ramp up into significant program quantities, we're very excited about that.
So Chris on that last part you talked about up to 24, but when I think about you know five years from now you know if for example, if dynamics is growing faster than rest of the company do you see the overall portfolio of the three segments. The same relative sizes and that long term timeframe five years out.
I would say that I wouldnt expansion is the biggest piece by double yeah. If you start to get into the back half of the twenties.
Things play out the way, we hope to I think dianetics has more opportunities with the defense hardware side to really grow those into substantial programs, but don't forget I mean, we've got the <unk> program to ramping up on the digital modernization side, so that should be a big catalyst for us in defense as well. So probably you know back half of the year I can see that defense segment.
You know accelerating growth beyond what we're seeing in health and civil but I wouldn't count them out you know Robert point I would make as you think about the company five years from now that the health is primarily a kind of a people services driven business and I think it will continue to grow well and we will provide health managed services.
Active military and veterans and others.
But five years from now some of the programs that we've been talking about F pick a R. S eschmann there'll be an insignificant production.
And you know that will help to change the complexion of the company a little bit so that we have 15 or 20% of of our month over month production programs generating a higher margin than our average and what we're going through now in 'twenty three 'twenty two and 'twenty three is the development of the <unk>.
Programs in enduring fires is a high energy laser the common hypersonic glide body, which is just right ramping up and the stuff we're doing on tranche one by the way there is a tranche two and tranche three so if you think about what we will look like five years from now we will have the base business that we've always had and we will act.
Add to it.
Above that base significant production program. So we're really excited about the company five years from now.
Thanks, so much thanks.
Thanks, Rob.
Our next question comes from Cai von <unk>.
Please proceed with your question.
Is it expensive right.
Hi, Thanks for taking the question can you talk about if you've seen a pickup in award activities since the Pentagon occupancy limit was lifted in September . Thank you.
I don't I don't know that Spencer this that we've seen a noticeable difference before after quite honestly that wasn't really a constraint that we had seen I think the Pentagon activity generally has been as expected the bookings slow Roger mentioned, we did see a number of rfps dropped in our defense.
Business here over the course of October so that's been very active in our proposal pits.
Very recently, so that's exciting to see but the Pentagon volume I wouldn't say, we'd noticed a big impact per year post.
I'll comment I would make is bill a plant.
Finally was confirmed by the Senate and put in as the acquisition exec in the Pentagon and.
And I would say since he's taken office, we are showing sort of upbeat and activity Bill has been very accessible to industry there've been a couple of drivers try service meetings with bill and he is trying to I think accelerate the rfps and again outlays, where they need to be and I think that's a real pause.
Sign I would look more towards that than I would.
The occupancy limit on the Pentagon.
Well I I will confirm once it's delivered on the Pentagon or not I think we probably been in the Pentagon more in the last quarter than we were in the first half of the year. So I think it all bodes well that will increase the activity and we'll get some of these procurements under contract.
Great. Thank you.
Youre welcome.
Our next question is from Matt Akers with Wells Fargo. Please proceed with your question.
Hey, this is Eric on for Matt. Thanks, So much for the question I just honestly, our could you talk a little bit about the environment today compared to last year, what kind of impact have you seen in front of US here. So far offering if you think you'll get extended again into next year.
Yeah, especially if we compare it to last year.
Like this time last year, I guess I was optimistic that we'd get.
We get a bill before the end of the year and as we work out what happened last year almost took the whole first quarter to finally get a bill and that did have an impact and then it just caused everything to slow because you know you're capped at the prior level I'm more optimistic this year.
I can't predict the future none of us can but when we talk to our members of Congress.
I'm the senior Senator from the state of Alabama, They all seem to committed.
To get it done in the lame duck period after the election, and so I'm I have more confidence that we'll get a an omnibus before the end of the year, but you know no one can predict the future.
You know a lots of issues I think we're all.
Reading a newspaper about the election, and how things will go up.
But I am I I feel better today than I did a year ago that we're going to get an omnibus and will avoid the extended share that we had last year.
Okay. Thanks, so much sure. Thanks Sharon.
Our next question comes from Peter Arment with Baird. Please proceed with your question.
Yeah, Good morning, Chris Hey, good morning, Pete.
Hey, Chris maybe you could just update us on.
How youre dealing with labor inflation, just regarding any salary adjustments and how that kind of flow through and impacts the top line, how should we be thinking about that well definitely I. Thanks for the question Peter and certainly something we've spent a lot of time on.
Throughout the year and even most recently as a leadership team. So I think what we've been doing is obviously our merit.
<unk> pool has been increasing and we've seen that consistently over the course of the past two to three years and expect it will tick up again as we're looking ahead to 2023 so.
In the past that was a.
Sub 3% kind of annual pool, and then we'd have some one off increases over the course of the year I think what we're seeing now is above.
It's mid threes to four or higher in certain cases, and and so that will roll through the topline as a tailwind on the cost reimbursable programs, which I'm sure you're aware or in the in the order of 50% of the portfolio.
So that's goodness there on the top line contributor for growth in the balancing act is managing that on the fixed price in teen in programs and we've been successful there I would say that you know managing margins this quarter at 10 three.
Could've been better belief, we're looking ahead to a strong Q4. So we're very thoughtful on building our pricing up and then passing those inflationary cost pressures along to our customers, where we can certainly it'll be priced and as we put together next year's forward pricing rates.
But it's absolutely something we're spending a lot of time on as a management team in and being thoughtful, especially for the areas of talent there in the highest demand.
That's helpful and just as a follow up Roger can you maybe just update on the AAV since screening business I know that you know you kind of put it out there that this was still going to be a recovery or in 'twenty four but just any kind of green shoots you might be seeing there. Thanks.
Yeah, I see if I can do this quickly.
Hum.
And we've always described you know the U S business is sort of an RFP against certified compete for the business and.
And it's funded really through authorization and appropriations that business continues to go well there's opportunities to insert new technology, what we call C T or computer tomography, yet at the checkpoint for carry on and we're in the process of getting our equipment certified and we continue to see.
Success domestically or in the U S along with our competitors. So that's you know that business is great.
What will really drive growth in that business as the return of the international business and that.
That the international business tends to be funded by a ticket surcharges. So it's more related to travel volume.
Then it is in the U S, where it's essentially funded by the federal government and show it and it's a lag. So the tickets traffic has to come back the ticket volume has to go up.
The airport authorities every.
The airport has a different governance structure they have to be confident that the volume is there and then they started to engage with the contractor base they've put out Rfps, we go and talk we do demos.
And then it takes literally months or a year or two before there's an acquisition you get certified you got an award you build the equipment you deliver it. So unfortunately, there's a long timeline to this recovery, but the good news is at the front and the RFP activity there.
Almost the requests that we have for our specifications and and and the like.
Is up significantly year over year.
And I said our team is literally flying all over the world are talking to airport owners and operators about.
What's available and yeah I'll make another point.
Done this before during that period, you know kind of the Covid period.
We're going to use that as an opportunity to up our investment in technology and our product is we wanted to make sure that we had state of the art detection equipment. There are a variety of of new substances that airports are wanted to detect fentanyl being being one of them and.
That required us to tweak our algorithms there or some other reasons why we tweaked algorithms and in the U S. A.
But we took the time right. When you know maybe production wasn't where we wanted it to be but we took our team and used it to invest in technology to make sure that our products were worldwide competitive and and now we're benefiting from that is that we are at the leading edge with our competition.
On what we have to offer and customers realize that and they they've asked us to come and talk to them. So we're excited about especially in the European market. Peter I'd say, that's probably the area. We're seeing the most receptiveness. We've had the most visits there's probably some things that you know we're more optimistic on their hopefully Asia will follow but that's probably fair.
They're behind I think everyone knows that China is still essentially shut down for COVID-19.
It does dampen travel in the Pacific region, but you know Christmas right. We've we've had a lot of trips to Europe .
I appreciate all the color. Thanks.
Our next question is from Colin Canfield with Barclays. Please proceed with your question.
Hey, good morning, guys.
Under the defense production in airport recovery comments can you just maybe talk us through the margin bridge from here to 2024, its investor day target of overtime, 0.5% and then maybe discuss which programs that you guys are developing under fixed price and how you think about kind of that cash risk versus getting to production.
Yeah, Carl I'll start and Roger can pile on so certainly the margin bridge.
Roger was asked earlier, we're not going to paint a detailed twenty-three picture at this point in time, but.
You know the good news is when you look at how this quarter played out I think that's indicative of you know a.
A great jumping off point right health kind of came back to where we expect it to be more on a normalized basis, we'll have some up quarters and down quarters, but mid teens was kind of the baseline and to you know give us a platform to potentially expand from there civil showed what it's capable of with a modest increase in volume of security products and.
Good management and I'd say, the defense side of the businesses, where we have some more opportunities to increase margins right. So you know balancing all that out I'd say looking ahead to twenty-three coupled with the inflationary discussion earlier.
We'll put together a plan that keeps us.
In the tens and where that falls out more work to be done, but I mean, I like the portfolio, but definitely when we get to 'twenty four and we've got more production oriented outputs a bounce back in S. E. S. That's why we feel more bullish on the 10 five plus margin target longer term. So I think we're in a good place.
To bridge that I I don't know if it'll be an up year, a flat year, but more to come on that when we gave you the 23 guidance.
Yes.
I'll just add a sensor to they're kind of put some.
What Chris just because there are really two ways you can drive margin performance on the existing contracts and then changing the mix. So that we have programs that on their face have a higher revenue opportunity.
We have always focused on performance and that's you know write ups versus write downs and control of indirect costs and overhead.
And we're a very lean company.
We have less than 100 senior executives in our company around a 15 14 billion dollar company with that and we continue to focus on that.
Where we've had success, but in our success, we are not adding to your corporate office overhead and indirect.
Indirect costs.
And then on mix and that's been our story now for years is that we do have in our portfolio. Some are businesses, where we operate Antarctica. We do large M N O and those tend to be below the corporate average and over time in those very important programs important programs for the nation, but we wont occur.
Implement those with programs that have higher margin potential and we talked about production programs earlier, even in some of our digital transformation programs. If we can get the special project work. If we can do enhancements. We can we can drive those to the higher margin. So we do all of that the 10.5 is achievable.
Yeah go ahead.
Got it Okay, and then it looks like the <unk> put out a strategic plan on Friday and it seems like the plan suggested that we get to a 100%.
That makes us sentiments roll up by 2024. So if you can just maybe update us on the revenue cadence around that program and kind of how that multiyear stepped down interacts with your health margins.
Yeah, Colin So again I think the team has done excellent job Genesis has been a growth driver for us This year and we certainly are pivoting into a point, where it's going to taper down a bit and we're approximately two thirds deployed through.
Through the program at this point in time right. So twenty-three will continue on that cadence what I will say is certainly the customer and Roger can elaborate on this there's been a lot of discussion you know getting the based appointments, but then enhancing the capability of the software suite that they we've got available to the customer and there's been a lot of.
The discussion and opportunity and growth that we'll see coming on the back of that that take full advantage of what the capabilities are so little early to paint the picture on how much of a step down we'll see as the deployment moderate.
But we're very cognizant of that and the health team has been working hard to find opportunities to offset that Roger you want to.
No yeah, we've we continued our deployments through hurricane in and.
Or really on schedule to finish the program frankly on cost are under cost.
And on an on schedule.
The you know the dim sum program is probably below the average in the house groups. So if you kind of understand the portfolio.
Very solid program, we're excited about the performance, but there.
There are just the way that portfolio shapes.
And the nature of the programs.
That as it tails down and we replace it with other work frankly, there might even be some opportunities for margin improvement, but the volume is definitely going to come down and we're trying to get to a position, where we're doing the operations and maintenance of.
The system at all the military treatment facilities.
As we've said and I'm sure you follow the program from the beginning you do get to the point, where you've installed the the Cerner Genesis software and all the military treatment facilities in the program takes a different shape.
Yeah.
Got it thank you for the color.
Thanks, Paul.
Okay.
Our next question is with Burke's who've been with Stifel. Please proceed with your question.
Hey, good morning.
Good morning.
Maybe staying on the health side of things.
Packed act should result in an uptick in the VA backlog, just as better at and start applying for those benefits and compensation, but Chris you are you seem to know during your prepared remarks that you arent seeing that yet how should we think about that bill impacting both <unk> sales and then into 'twenty three and is this something that could get health back to year over year.
Both.
Well definitely I mean part of what we're not saying is that the the VA didn't necessarily set up a way to track that explicitly just yet so the team is working to make sure we understand what coming through as a pack that case for us otherwise, but you know I think that the main point is this is ahead of us right so and.
Yes, it could be a contributor to the fourth quarter that would be something if it were to happen could be one of the catalysts to push us up in the margin range. As an example, right. So that's why there's a range there, but certainly for 'twenty three.
Bullish on how that plays out.
And we've seen good overall referral volume you know we are navigating throughout the year. This.
Recompete and reallocation of some of our other work to multiple competitors that for the most part that's settled out maybe there's a little bit more of that to go but I certainly look as the pack that case volume to be one of the areas that can drive growth for us in 'twenty three.
Okay, and then just on your comments there on sort of the margin and EPS range. The narrowed guidance that you guys have implies a pretty wide range of potential outcomes for <unk> I think from anywhere from $1 44 to 164 in earnings.
It would be at the midpoint below what you've seen sort of each quarter. This year.
Just curious what's driving that expectation and if you guys were to end up closer to that low end. What do you think would have driven that yeah. I mean, a couple of things going on there. Obviously, we'll still see interest rates have been trending up right that'll be a little bit of a headwind as we look at the fourth quarter on the below the line item.
Our diluted share count we're at 138 rounding down I mean, there's a scenario where it could pop to 139 in roundup. So that's kind of in play there and then we talked about the tax rate right. So taxes were.
A driver of the tax rate being higher than we expected at the end of the year. It seems working hard as they always do to minimize the tax expense, but I'd say, it's more of the you know.
Below the line items that are kind of in play there I think operationally, we feel solid about the trajectory of the business.
And just a clarification question Roger for you if I could quickly I'm sure. You you noted some positive commentary on S. DNA are you sticking with sort of the 'twenty 'twenty four full recovery timeline.
Yeah.
Yeah, Okay, we expect in 'twenty four to be at or above pre COVID-19 levels.
Great. Thanks, very much yeah. Thank you.
Our next question is from Alan Page with Jefferies. Please proceed with your question.
Okay.
Hi, Thanks for the question.
Understand that you don't want to give twice.
Guidance, but are there any major program drivers beyond just it doesn't our HRP.
And we always hear about your successes, but are there any losses to be aware of.
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Sure Allen So I mean, those are the bigger ones, obviously, the SSA. Our HRP, we just talk a little bit about the pack to act on the disability case volume and where that can play out.
Aegis, we'll have a full year of volume so that's great.
And you mentioned as well right. So those are some of the ones that are kind of in the bag that will be growth catalyst.
We'll see.
It's not a recent loss, but the NGA items Uff's contract. For example, we talked about that at the beginning of the year as a loss we continue to execute on that for you now.
Half of the year through the third quarter that will fall out of the portfolio. So that's one of the headwinds that we've will have but more recently, our recompete win rate has been quite strong.
And so feel good about that and so I can't think of another material downer that we'd have to overcome a heading into 'twenty three.
What's been great about the journey at lighthouses.
Losing a billion dollar program.
We were you know five or 10 years ago was really really material for us.
Now we are bidding you know probably north of $50 billion worth of stuff in a year and so if we were to lose a $1 billion of programming and clearly we don't win everything and so there are programs like that that we have not won usually new business and takeaways not a recompete.
Tends not to have a significant impact.
All companies do this you know, sometimes we stretched a bit on something that's maybe a little bit outside the strike zone, and we lose those but it helps to build a relationship with a customer and then maybe when we bid. The next program, we windows and like all companies there are we.
We do lose programs.
Not every week, but often.
But we went a lot more than than we lose which is what we're trying to do and you know.
As Chris said, we have a lot of work to do between now and the end of the year.
It's amazing how many rfps have dropped and how busy our team is frankly across all five.
Five of our business groups in three of our reporting segments and writing proposals over the two holidays, which tends to be the way things work in our industry.
Great that's helpful.
And just on.
Profitability was a little lower in the first half how do we think about.
Revenue and profitability on that program in Q4 and beyond Yeah. Alan I think that's one that I would say the best days are ahead of it as far as profitability goes quite honestly revenue is settled.
Settle into a nice range team's done a great job staffing levels are robust and so you know our team D. J a program manager Stifel. Our ops manager have done an excellent job preparing that program for success, but I still would say yeah, we our expectations. Our margins will continue to tick up I don't think.
You shouldn't expect significant movements, but it should be a nice tailwind for us as we look ahead to 'twenty three and beyond.
Great Thanks for that.
You're welcome.
Our next question is from Mariana Perez Mora with Bank of America. Please proceed with your question.
Good morning, gentlemen, good morning, good morning.
So let's talk about <unk>.
The acquisition close what's your appetite to increase international and or made Tom exposure.
Yeah.
International.
Maryann I would say well, obviously, Roger talking about call them extensively very excited about that one.
No we've got a large presence in Australia, just like we do in the U K. So certainly those would be areas that were quite comfortable adding more capability onto and then you know internationally. Our NATO has been a customer of ours. Historically, we've done some some excellent work for them some challenging programs and some very successful programs.
But I don't think you'll see a scattershot of of other international Beachheads I think will be very selective where we have you know kind of a major muscle movement, obviously, our SCS business does a lot of work internationally. So that's one that you know if there's areas to complement their capabilities from a service delivery perspective, we'll look to do that but right now I mean, there's probably playing too.
Our strengths and I would say our strengths of our business in Australia, and the UK as the top priorities.
Yeah, Mariano we tend to go where the U S goes those five countries are the NATO ally in countries and and then we tend to go where.
The World is complicated and right now Europe and the Pacific Rim are places that we see.
Growth and so we're excited about that and Chris mentioned, I think where we sell equipment through the S. U S business, maybe to a 125 different countries not all of that is direct some of that is through manufacturers reps, but we have people.
Probably in 40, maybe 45 different countries supporting some of the NCS products are at a commercial airports. So.
Right and then would you mind reminding us from an M&A point of view.
Cat in terms of like capabilities customers contracts.
To add to your portfolio.
Yeah, well you know we've been talking about M&A, you know for quite some time.
And yeah first a foot stomp you know, we don't feel compelled to do a big M&A, we like the portfolio, we like the size scope and scale of the business.
It's really opportunistic and in places, where we can either add a new capability that complements an existing line of business or we get access to a new customer the comp on that acquisition is really is an example of a capability that we're very comfortable with we actually fly the same type of aircraft chat.
Injure, a 600 fifty's and dash H so.
Really familiar with the hardware, but it allowed us to extend to a new customer in Australia.
That's really really important to the country, Australia has literally thousands of miles of coastline and a really important that those are.
Surveyed and if they provide search and rescue services and so we saw that in combination with our existing footprint in Australia to extend our business into access a new customer base that we had access before so it's a perfect example of of what we would look for but I will Oh.
Foot Stomp again, we're not in an aggressive posture on M&A I think we're gonna be opportunistic as we go forward and execute on our our book of business and deploy our cash in a way that creates value for our shareholders.
Thank you very much well thank you.
Our next question is from Tobey Sommer with Securities. Please proceed with your question.
Thanks.
A product standpoint, and solution standpoint sort of the higher margin areas of the business.
Where are you from a mix shift perspective sort of where the current portfolio is versus maybe what you aspire to over time and do you have any visibility to that.
Improving or increasing into next year.
The Leo satellite, which is why <unk>.
Yeah, and you know Tobey Oh, we don't put out hard numbers I would tell you from a solution standpoint, we're pretty comfortable with where we have moved and the value added work that we do the special project work, we do on some of our contracts.
And to provide a solution to a customer we really worked hard.
To position the business in that way from the actual hardware component and by the way we love to make hardware that's part of the bigger solution, where those things go go hand in glove.
But we you know we've been working through a program wins and through M&A to add you know a slight bit more hardware component to our offering by the way it tends to have very sticky IP. If you've got a manufacturing facility you tend to hold onto the program they tend to be long.
Or lift as programs go you know you have a five year production runs you have 10 year production runs.
And although we have some things that are in production.
Our hope is to add you know four or five products to our production portfolio and as we said you know at a at the beginning you know.
Five years from now to have a more significant part of our portfolio is actually connected to some hardware.
And to follow up on the prior question about sort of M&A I know you've put stops stuff, but from a.
Market perspective, with higher rates and.
<unk> P E, maybe not being able to pay the same kind of multiples they otherwise would be the lower leverage and higher interest.
Does that over the next.
So many many quarters.
Provide a better opportunity for strategic buyers such as your health sells with the financial flexibility to.
Maybe compete even more successfully on a go forward basis for acquisitions than you might have been able to in recent years with low interest rates. Yeah. I mean, I told me. It's it's a it's a good theory and I think there's a strong basis in the points that you make.
First I'd point out is P is still very strong in our markets and you know without going through some of the specific firms. One just did a 10 billion capital raise and so there seems to be a lot of money available.
Available to private equity so we don't see them are leaving the market.
Interest rates drive up the cost of capital for everybody and it does change the business case, but we also would change the business case for us due I think strategics kind of come back with a little bit more.
Our balance sheet power and then putting in the market yeah. It it could happen.
What we try to do is not get tied up in the kind of it's a good interest rate. It's bad interest rate, we really try to look at the fundamental strategic fit of the business and then see if we can get it at a price which closes on a business case and we've used that approach in everything that we bought and that's really how.
How we do M&A going forward and you know interest rates come and go P can come and go and we just need to stay close to our strategy and are hitting and by those things that makes sense for us.
Thank you.
Hey, Maria it looks like we're just at the top of the hours. So I think we have time for just one more question.
Yeah.
Okay.
Last question is Ken Herbert from RBC capital markets. Please proceed with your question.
Great. Thanks for squeezing me in Roger I, just wanted to ask you you've got a.
Really a number of opportunities on the hardware side.
And as I think about your defense portfolio and you've alluded to an anticipated step up in 'twenty four and this business what should we focus on are what are the key milestones in 'twenty. Three if you look at that for the portfolio either in terms of.
Contract milestones down selects how should we think about tracking this through 'twenty three in and what could you highlight as sort of a key watch items, yeah, well again, a great kind of a provocative question, but what are the good news is lots mhm. So so no single program no single.
Oh down select drives the business, we've got to get.
A wide field of view trial zero up into space, where you're gonna get tranche one up in your space, we've gone to a transition.
Our enduring fires, both the enduring which is the missile and the high energy laser we need to get those in to test.
We have some things on the weapons side those needed to get into test.
On.
The airborne we need to win the next airborne competitive program with the army for their enhanced ISR program, which is.
Bombardier 6500 class aircraft and so yeah, we just go around the portfolio and it's a lot of.
You know I won't call. It you know the singles and doubles, but it.
It is world series, Susan So they really are kind of singles and doubles. There is no big homerun out there that we need to execute the strategy.
And so you just kind of look at the press releases and we went in the programs that they have hardware content are we successful in getting these things feel theyre getting things in orbit.
R. M U V program that I talked about so we know we're going to get we now are in development. So that needs to go you know P. D. R. C. D. R into production when you start building you vs. Yeah. They're just continue in that vein you cant I would again not to I feel like we're on Michelle for the dynamics visit but.
The team will certainly talk in more detail at the end of November December 1st on what some of those milestones look like and and so Roger just hit on it. We're excited that we have more than a handful to focus on.
But we've got the right team executing against that and you know there are some things where hopefully will be some some additional contractual orders, you'll see out of Ses and maybe a low rate production order out of dynamics, but again.
That site visit will give you an opportunity to dig deeper there.
That's great and if I could just one quick follow up you're obviously well positioned in a lot of growing markets relatively early stage in some of these how much is technology maturation of risk around you know just the government's ability to move forward on some of these to the scale in which we'd like to see.
Hum.
But that's it.
So oh I've come to Huntsville, So and we will talk about technology, we can talk about that technologies into different products.
First of all we want to have programs across the lifecycle of technology, we wouldn't be doing work with DARPA low level TRL kind of programs and then we wanted to have when we were starting to talk about production. Then those are higher TRL programs and if I think about say the if the enduring fires programs.
The technology risk is essentially behind us so we need to apply the technology, we need to make it work we need to connected to the fire control system, we needed to take it out on the ranges and shoot it and demonstrate it but from our invention standpoint.
We do that kind of work under we called 6263 kind of early stage programs with customers like the office of Naval research and a F R O and DARPA.
And then you know those are.
Take risk invest fail fast kind of programs and we love having those they are our people love working on those but the ones that are significant in our financials going forward. We've we've gotten through C. D. R. P. D. R. We bought down the technical risk and I think you'll be impressed.
First with the level of technology, we have in those programs and how mature that technology is.
If you can make it to Huntsville.
Great. Thank you very much you're welcome.
Yeah.
Okay.
Okay. There are no further questions at this time I would now like to turn the floor back over to Mr. Davis for closing comments.
Maybe I want to thank you for your assistance on this morning's call and thank you everyone for joining us This morning, and your interest in light OS. We look forward to updating you again soon have a great day.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
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