Leidos Holdings, Inc. (LDOS) Earnings Call Transcript & Summary

Okay. We've got the thumbs up. I guess welcome back, everybody, to those of you here in the room and on the webcast to Citi's Industrials Conference down here in Miami. For those of you that did not come in this year that are on the webcast, you are missing out on some beautiful weather and you should come next year. I have the pleasure of welcoming to the stage, Leidos and Chris Cage, the CFO of the company. Probably needs a little introduction, but I do like to give a little bit of background on everybody that comes up onto the stage. So Chris, you've obviously been with the company a long time.

Yes, 25 years. It's 1996, I think right?

And back on it was called CIC. That's right. In California got started in San Diego. Great. I do appreciate the fact -- I didn't -- I just noticed now the purple tie-in. It's awesome. We've been picking up all of these conversations with companies in my coverage universe this week with kind of the big picture kind of stepping back, we all, I think, understand the strategic posture in the United States and the threat environment that's out there and defense budgets have had quite a bit of support here over the last several years. I think that story is really well understood. And we'll get into maybe in a few minutes how you got all position yourselves for some of the messiness that might come upon us. But I think it might be fun for us to maybe step back a little bit and get a little bit of inside baseball from you in a way kind of some of the more informal conversations that are going on with your customers that are informing how you all are thinking about the future. We obviously have got a conflict going on in Ukraine that is informing some of the thinking that's going on. We're getting more and more nervous about the Pacific as well. So just be kind of curious to have you talk a little bit about some of the things that aren't programs of record today, but the conversations that you all are having with your customers where what are we going to be talking about a couple of 3 years down the road?

Yes. Well, first, Jason, thanks for having this out. A great event and always happy to get the opportunity to talk to more people in your coverage universe here. So our customers, obviously, there's a lot to be concerned about. The world is a dangerous place. The Ukraine war has kind of brought a lot of new things to light that gets us thinking about how do we position ourselves to respond as a nation to some of those threats. But the customers are also talking about the political backdrop and the frustrations with while we have a very strong budget environment today, finally, well-funded, it was late last year that it finally came out, but it came out in a good spot and the funding environment is quite strong. The question or concern is what's going to happen next? What's going to happen as we pivot to government fiscal year '24. Will we be in a continuing resolution environment which we have most years, but how long will that go on? And what, if any, impacts will that have on our ability to pivot as a nation to respond to these threats that are ever-growing? And the good news for Leidos is we're on a number of important programs that are in the early innings, development stage programs that are funded in the '23 budget. So even in a CR environment, those should continue and continue to be growth catalysts. But that's one area that they're concerned about. Obviously, they're concerned about getting capabilities out in the field more quickly, responding to threats as they evolve more rapidly. And we're seeing some customers able to do that better than others and setting up processes like other transaction authorities. So coming up with different contracting models to be a little bit more nimble and responsive to threats. And we benefited from those opportunities as well. Our Dynetics unit specifically is well positioned with some customers that have set up more rapid capability offices and things like that. And then the Ukraine is certainly teaching us that it's critical to be able to share information not just across the services but with our partner nations, right? And how do we share intelligence, how do we share data, how do we share the state-of-the-art capabilities, and systems. And so I think those are some of the things that we're learning out of the conflict, and we'll see where it goes.

Right, right. I'm going to jump ahead maybe because I did want to have a conversation about JADC2 with you all and Leidos' involvement in that. And you just mentioned the interconnectivity that we have with some of our allied nations. Maybe we can first start with the connectivity of our own branches of our military in JADC2. And to be honest with you, I hadn't really thought about it extending it out to the allies. I'd like to explore that a little bit with you. So if you wouldn't mind maybe just kind of walking us through your understanding of JADC2, what Leidos is, where it's playing today, where you're making some investments in it? That would be helpful.

Well, it definitely is the buzzword, it's been talked about in the past, but it really feels like it's got a lot of legs now, whether you call it JADC2 or multi-domain operations. We're definitely in that mix. Leidos has won a couple of important contracts that position us to expand the capability set in that regard. We won a program called Sentinel last year, and we're positioned on the Advanced Battle Management System program, 1 of 5 contractors position there. So we stood up a capability office. We've got a leader kind of over this area. We're putting some real money into investing in team and capabilities below that. But you won't see us in all likelihood come out with a proprietary set of products that are focused on JADC2 per se. It's more about the role we played historically being the agnostic integrator, making sure that there's connectivity, open architecture, modularity, of course, the systems that we are working on, such as some of the programs coming out of Dynetics, the enduring FPIC program, for example, will ensure that it's JADC2 enabled, if you will. So it's got the ability to connect to different services and different threat detection systems. But JADC2, I think, again, is something we're going to see how do these services play along because it's not going to be that many kind of central programs is kind of everybody's got to look to how do they open up their platforms and their networks to make sure we can talk and communicate effectively together.

Yes, that was one of the obvious follow-up questions to that is the different silos, right, because the Navy's got their approach and the Air Force. There's need to be some interconnectivity between...

There will be and so that again, that could be a second-order effect of how this evolves. That's why I feel like we are in the early innings, and it's critical that you're thinking this way and you're enabling this open architecture and this capability, but the opportunity sets, I think, are still emerging, like the Sentinel program, and there's been other contracts that have been let out there just to think about and to propose ideas and concepts where you can help enable more joint all-domain command and control capabilities.

Where do you think our allies are in their capability sets in this area?

Well, that's a great question too. I think that there's a lot of barriers to overcome before you're freely sharing the full set of intelligence capability and data. I think the ACAS agreement helps in that regard. I think it's a good first step. I think certainly, some of our close 5 eyes partners will have a lead position on. But again, these are learnings coming out of the Ukraine conflict and how they resonate back with the next generation of programs and opportunities. I think we'll still see how that plays out.

Yes. Yes. Okay. Maybe shifting gears back to bigger picture things and give you an opportunity to talk about some of the long-term strategic priorities at the company. I know you've had an Investor Day here recently down in Alabama with the dynamic facility. Unfortunately, I couldn't make to that. Obviously, space and the things that you have going on there dynamics were obviously pretty important to the future of the company. But we're sitting here 3 years from now. what are you talking about as far as what you've accomplished over the prior 3 years? And what are we talking about for years 2017, 2018, 2019 going to the end of the decade? What's going to be topical then?

Well, I think a lot of the same things we're talking about now because unfortunately, things don't move that quickly, especially with our government and the world the way it is. But you're right, Dynetics in Alabama is in the middle of some of those strategic thrusts and imperatives. Clearly, the China threat is the big deal, right? And fast forward 3 or 4 years and what's the posture with Taiwan, what's going on there is something we have to be prepared for as a nation. Hypersonics is a critical capability, and we are in the middle of a number of hypersonic programs. Again, this is one we see with potential significant growth opportunities ahead of us. So we're on the conventional prompt strike common hypersonic glide body program. The long-range hypersonic weapon launcher program has been one in the arsenal. We've most recently won the Mayhem air-launched hypersonic weapon program, and we've got a mock test bed. So that's another area where the government recognizes we need to make this kind of more affordable. One of the ways you do that is to be able to try new capabilities, fail, learn, embed that into where it's going next. Well, we see a lot of those things ramping up and then we're on the defensive side of that, too, with the space satellite space payloads, widefield of Tranche 0, Tranche 1 is space detections critical. So clearly, a lot of bets have been made in the hypersonics arena. We think that, that's got a lot of growth capacity in front of it because China has tested a lot more weapons. They've proven that they've got a capability at this point and looks to be a step ahead of where we are as a nation. So that would be one. Maritime is another critical area, again, focused on what's going on in the Pacific. We've made bets. We acquired a company called Gibson Cox a little over a year ago. And they're in the naval architecture engineering domain, we couple that with our capabilities in autonomy. And so we think both the surface autonomy and undersea autonomy are critical is where we're going as a nation, and you'll see more programs and opportunities programs of record to have the capacity, both in the large, medium, and small surface vessels and then the undersea. We won the medium unmanned undersea vessel program last year, and that's hitting a production cycle starting in '23, and that will be a program that ramps up over the next several years. So excited about some of those bets and where we're going with those capabilities and that growth opportunity. And then looking ahead to what's next. I mean, I think he's not in the DoD domain, but investments in our security and infection equipment, right? And the next generation of airport screening equipment, baggage screening equipment, the threats are evolving and you have to be a step ahead of how do you have the latest algorithms. How do you have more passenger throughput, how do you have increased touchless, frictionless environment? So we're excited about the next generation of the products we're offering there and the demand signals is coming kind of globally around some of those things.

Right. I think you've had a press release out maybe last week. Yes, it had been last week because I haven't been able to pay attention to the news as much as I would have liked this. But on the security detection side of things, some sort of upgrade to the existing installed base. How important is that would you rather be doing software upgrades or installing all new hardware? I mean growing your installed base, obviously, is important, but from a business model perspective and profitability.

Well, that's why it is a complicated business model and the installed base is important, but the life cycle around that and software is becoming increasingly important as a differentiator, and having the ability to provide upgrades over time gives you another revenue stream as you enhance your capabilities, right? And so you get the unit sale and the installed base, you have a maintenance agreement over time. You have spare parts warranty. And so that whole long tail because these are units that can have 10-, 15-year life spans. The software now becomes a more critical piece of the equation that our current leadership team has done a really good job of being innovative in that regard and looking for, again, how do we modernize some of that and provide it over a set upgrade cycle. So we've been in the ports and border security business coupled with the aviation security business. And so now we're seeing some early signs of the aviation market globally coming back. We had an announcement on a Frankfurt opportunity recently, and then we had an announcement for that in London, London City Airport. So some great signs of that business coming back, but it's a business model that you really have to think about the whole 10 or 15-year horizon of the units that you're putting in service.

Anything on the healthcare side you want to mention?

Well, we're, obviously, very pleased with our healthcare business and how it's performed. We've had great success deploying the DoD's electronic health record system, that by all accounts has been a huge success. We're meeting schedule. We deployed multiple waves. And I know the VA program, which we're really not a part of hasn't gone as well, and that's just an area that we all tell, "Hey, the VA, send an Oracle, we're here if you need it or help." So proud of what the team has been able to accomplish. Obviously, recent legislation with the PACTA means veterans are entitled to some additional benefits. We do a lot of medical disability examinations and benefit processing for veterans. And so that's an area that should be a nice uplift for the business as we help them get what they're entitled to. And then we just see a robust pipeline of opportunities. So again, no shortage of emerging needs on the IT side, whether it's in CDC, the HHS, we had a nice win with Social Security Agency in the fourth quarter, and that's a great contract for us teams doing an excellent job.

How much shaping gets done with those kinds of programs? Are you in early and helping?

Absolutely Yes. I mean I'd say shaping we call it left to Win plan. We've got a large cadre of whether it's our program managers that have responsibilities on delivering on current programs but also helping customers understand how they can meet other needs. Our business development marketing teams, we have our strategic account executives talking to key stakeholders and our customers about what are their issues, what are some ways Leidos could help those issues. So you really need to have that whole perspective of what's going on in a customer environment, what their challenges really are. If all you're doing is waiting for a customer to put an RFP on the street and you're reading that along with everybody else and deciding how you want to respond to it, you're a step behind. You got to kind of have the knowledge and awareness about what's not being asked for on the paper, what they really need, right, to put forward the most compelling solutions. So on the biggest opportunities and the biggest jobs, we have captured teams that are working sometimes multiple years in advance to go after opportunities that are that large and complex and really need the most integrated complex solutions to address.

Right. And speaking of the procurement process, maybe you can talk a little bit about what you guys have seen maybe over the last 6, 12 months on the ability of your customers to get RFPs out and then actually get the awards made get through what is inevitably probably a protest or to and finally get things on the contract and programs running. Is it getting any easier out there?

Well, it goes through cycles, right? We were all a little bit frustrated in '21 and then the early part of '22. Again, the budget took a long time to get put in place. It finally got put in place in March. It didn't kind of shake loose overnight the next day. But slowly, we saw behavior improve over the course of the summer. And for us, we had some of our best growth quarters in the back half of the year. I think the industry overall and some of our competitors had good growth quarters in the fourth quarter, indicative of, hey, things are now happening, right? There's more volume in the system. There's more expansion on existing vehicles. And then for Leidos, we had -- and we talked about this in our earnings call last week, we had an exceptional fourth quarter as it related to the new summits that we were responding to. So we had a very active fourth quarter, again, which was indicative of RPs finally came out. Customers maintain schedules, and we were able to submit a number of what we hope are compelling bids. It never ends. We're constantly in the proposal pits but we've certainly seen times where there was a little bit less activity. And I think that we've seen some improvement in those trends more recently. We've also seen some customers look for leveraging agencies like Fed Sim, who does a great job with their proposal process. They run things on time, on schedule with kind of well-defined criteria. And so some of those things have helped to move procurements along at a more rapid pace.

You mentioned OTAs earlier and for those in the audience and on the webcast, this is a contracting mechanism that allows -- I don't want to stick it around far, but it is a more expedited version of or, I guess, is the right way to put it. It allows buyers to go through a procurement process and an expedited process. So tell us a little bit more about what you're seeing there. Are you seeing that just in like really niche areas? Or is that kind of a trend we're seeing a broad base that may actually help you all out?

Well, it's a good question. I haven't seen it pervasively. It's definitely been in kind of more of the emerging areas, emerging capabilities, new programs, right? What's the new start areas that they're looking to get things out on the street. And again, the rapid capabilities, the technology office with the Army has been one to use those. Now there's good and bad with an OTA. I mean there's some limits on the profitability you're able to make on those, but it's a trade-off. Typically, if you're in the early stages of some of these programs, development stage anyway, those are going to be under a cost-reimbursable type arrangement, most of the time because of the risk involved. And so OTAs can work well there. The government is taking more of the risk and the contractor is getting a fair return, there's speed and certainty of execution. That's not always the case. But we've seen it here and there, I wouldn't say pervasively, but Dynetics, especially we're really strong. You got to have a certain type of organization to be qualified to receive an OTA, and Dynamics have a great history with certain key customers that they've leveraged that more so than kind of the other parts of the company, although I've seen them here and there as well.

Okay. Great. You've just mentioned cost-reimbursable programs, which the flip side of that is firm fixed price right? And we had one of the major primes here make a disclosure recently on a contract that they signed prior to March of 2020 on a firm fixed price basis that there's the potential for them to struggle with on a cost side of things. So I think it's probably fair for me to ask. Is there any firm fixed price programs that you all signed prior to March 2020 that we should, as the investment community ought to be aware of, be watching closely?

Well, so the answer is, yes, there's definitely fixed-price programs we signed prior to March of 2020. As it relates to being concerned about that in the grand scheme of things, no. I mean we don't have any long-term production-oriented programs to be concerned about at this point in time. That's kind of the good news about where we are today. We're well positioned with a number of early-stage developmental programs that are transitioning, either about to or have more recently into low rate production and full-rate production. So we're looking forward to the future about being into a fixed price production model, and we have the benefit of being eyes wide open around the inflationary environment that we're in, supply chain concerns. So as we are bidding on those programs today, we're taking all that into consideration. That being said, offsetting the impacts of inflation both on labor and on materials and everything owes an ongoing battle. I mean, it's definitely been tough for the community, but we're not in a situation where we're looking at any material programs and saying, "Hey, we're upside down or we have a loss leader." I think what it does is it takes away some of your levers for that would be margin improvement opportunities. I'm proud of the way that we've held our own on margins. We finished the fourth quarter with our highest margins of the year at 10.7% on EBITDA. And so even in the face of increasing cost pressures, we've shown that we can navigate that and deliver strong margins. And the other thing about us is the services business, you do tend to turn over parts of the portfolio more frequently. And every year, we're able to submit an update a set of pricing rates to price the new work off. And we've certainly taken into consideration what we're seeing both on the labor side and to the best of our ability on the nonlabor side as far as cost increases as a part of that. Yes, it's not easy, but we're looking at other levers, too, is how do we get more efficient in everything else we do. If certain programs are going to be less profitable because my input costs have increased how do we offset that with reductions in things like facilities? And we talked about that again more recently, we've had we call it strategic occupancy reduction program. COVID changed everything, and I think people have been adapting over the course of the past couple of years of what it's going to be like going forward as far as in the office work, work from home. So we've got a better beat on that, and we've got a better understanding of what our facilities needs are and our footprint needs to be. And so you saw us exiting certain properties earlier accelerating some of those things, and that will help us gain some efficiencies going forward.

Right. You mentioned development programs transitioning into production where you will be signing from fixed-price contracts. Are there some lessons that we've learned from the pandemic is inflationary supply chain environment where you're going to be able to get some better protections into these firm-fixed-price protection than you would have pre-pandemic that you would have ever even thought of?

I think absolutely. Everybody has opened their eyes to some contractual clauses and language that we've got what inflation protection playbook. Our contracts and legal team have been on the front lines, thinking about how they protect the company. And so oftentimes, if you don't ask for it, you don't get it. But if you ask for it, and you negotiate it for it, especially when you've got some negotiating leverage, then you can get some price protection clauses in their inflationary protection clauses in there. So we're definitely well aware of that and where we can, it's more difficult, obviously, to get reopeners on existing programs nothing that never happens, but certainly on the new bids going forward, where we need to, ensuring that we're negotiating for some of those potential inflationary reopener clauses.

Right, right. Okay. Great. Transitioning really quickly to it's a big-picture question from a philosophical business model perspective. So asset intensity I think gut reaction is Leidos is a services company being much more than that at this point after the Dynetics acquisition. You've got the security business as well. And whilst the business at Covanta you picked up is going to be a service in the end, you've got to have assets to be able to provide the service. So that's a different flavor to it all. Can you just kind of philosophically talk a little bit about how you all are approaching the business and how you're going to be describing the business in the future? Is this a services company that's asset-light, low EBITDA margins relative to an asset-intensive business or are we transitioning to something different? Are we going to be a hybrid? What exactly is the philosophy here?

I mean I'd say more in that hybrid camp. We didn't just arbitrarily decide we want to do products. We had certain aspects of products in the portfolio historically, right? They were never big enough to be featured, but again, our ports and border security products business that goes back decades. And so that's the great thing about having really smart people working on cool and emerging technologies is that it can lead into a particular opportunity that can be productized and sold repeatedly. And we always had this innovation engine, we call it Leidos Innovation Center, LINK. And a lot of PhDs, really smart people working on contract research for places like DARPA or Air Force Research Laboratory, cutting-edge technologies and capabilities, but we never had the mechanism to do much with that other than the paper study, right? It's like, okay, and then somebody else takes those great ideas and turns that into something that they can produce into a real product and make more money on Dynetics brought us the ability to kind of take that several steps for them. When I think about where we're going, I mean, we've said products is roughly 10-ish percent of the portfolio today now, and that includes the services EcoStream around the product itself, the physical product sale. We're only going to be looking at products that kind of have ancillary work with them. There's a logistics tail. There's a services tail. There's a maintenance tail that goes with it. And so we'll probably see that grow, but it's not going to be the dominant portion of the company. And so I think it's a nice complementary fit with what we do. And now that we've got kind of the Dynetics platform, really leveraging that more holistically to say, hey, the other things that we are doing in other parts of the company, how can they be better integrated together with a common that are processes in the manufacturing environment, we call the Manufacturing Center of Excellence common tool suite to manage your inventory and production schedules, et cetera. So that's where you're seeing some of the investments go. But we'll still be a services technology company at its core with some critical low-rate project products that are in the mix.

Okay. Great. Maybe shifting gears really quickly to some of the commentary that you all had last week on the political environment and the budgets and the potential for a CR, you guys were, I think, the first to kind of really enlighten us all on this risk around government shutdowns and getting prepared with all that. So maybe we could start with what's in your baseline assumption now in the guidance that you provided for 2023 as it relates to CR and shutdown?

The operating environment? You're right, and we weren't trying to sing doom and gloom with any of that. It's just, hey, let's all be eyes wide open to what's going on out there. And we put out revenue guidance of 2% to 5% for fiscal year 2023. We're just coming off a year where we finished at approximately 5% growth. Our fourth quarter was 6% growth. So we've been delivering actually at or above that clip or certainly the higher end. And we would like to feel that's definitely sustainable because the budget environment by now is very strong, right? So the budgets came out, as I mentioned, a little later than we like, but they're out there, Robust growth in the DoD space and other agencies benefited from that too, more money to offset inflationary pressures, et cetera. So the budget environment today is strong, as we just talked about, we saw that translate into increased level of procurement activity. I feel really good about all that. So that presents us up well. But then you look ahead to next government fiscal year. And we'll get the President's initial budget, hopefully within the next handful of weeks, but it's probably sometime in March. And where the debate out is what is that going to look like, what kind of budget request growth is he going to show in there. We think it will be a healthy budget. What happens in getting that budget implemented and executed with Congress, that's where the uncertainty lies. And our baseline assumption is, "Hey, we're going to have a continuing resolution for the last 3 months of this year." Now we didn't have any commentary on what happens in '24 just yet as it relates to that. I mean there is certainly a scenario where you have a year-long CR or a multiyear CR if you just can't get like-minded on setting a budget. But just for this year, if a CR happens to the end of the year, that's not a terrible outcome, right? I mean, coming off of a strong budget environment continuing that pace in and of itself should be okay to sustain the optempo and the growth rates that we've been seeing as long as customer behavior doesn't change because that's the dynamic, right? It's like then they get nervous or anxious is, hey, how does this play out? What happens if the CR feels controversy or elongated? Are we going to ultimately face some budget reductions? And so you've seen behavior in the past where they tend to wait on decision-making and hoard their resources. And sometimes that leads to extensions of current contracts rather than new awards, right? And I don't know that's the base scenario. I hope that's not the base scenario, it's not what we're seeing today, but that is a possibility, right, which is why we have the guidance range, there's a lower end that, hey, things are a little bit more backed up and elongated. We're not seeing decision-making happening on a timely basis. I think that's obviously bad for the nation. That's not good policy, but it's one yet ready for nation.

Right. And historically, you mentioned historic behavior is there any learnings from that? At what point do they start to get nervous? It's rolling in February now. But do we get into May and June and like, "Oh my god, October is not that far away, and that's what it happens?

Yes. I think it's in the summer. And again, you'll either see different customers have different behaviors. Some are more mature about it. But you'll see one or 2 things. You'll see customers putting the pedal down because they want to get their money obligated make hay while the sun shines and we like that behavior like let's get some things done and you have others that, again, tend to be a little bit more paralyzed and maybe that's a reflection of the leadership at the top or just lack of strong depth in their contracting shops because some customers suffer from that more than others. But I think it's usually in that, hey, June, July time frame, you're kind of closing out Q2, you start in Q3. What are you seeing as it relates to customer behavior at that point in time.

Okay. Well, I keep asking you the questions. Every time I see to see how things are going. Speaking about us, I think March 9 is the kind of [indiscernible] from tomorrow. Anything that you're going to be watching out for in particular in the budgets?

Well, obviously, where most of our business is concentrated in the defense segment. So obviously, what happens with the DoD is practically important. We'll see what happens as has happened in past years, which is the compromise has resulted in other agencies getting uplift as well. We think there's a lot of great opportunities for us. The portfolio is pretty diverse in Leidos, and we have a lot of civilian agency customers. And so ensuring that customers like the IRS and treasury are well funded and continue to be that there's opportunities for IT modernization there. But for the most part, it's like as defense goes, everything else goes in that budget, you're not going to see what's happening with the intel community. But separately, obviously, that's a material area for the business. And their mission space is kind of changing and evolving a little bit, too. So the dynamics there will be interesting to watch.

Yes, this is all going to be faster than you're going to watch. We do end up there with a shutdown at some point. Can you talk a little bit about the level of work that gets done kind of on-premises with your customer? And I don't know if you have the mix right off the top of your head, but I'd just be kind of curious to know how dependent you are in having access to government facilities.

That's been critical in the past. I mean, I don't have the mix right off the top of my head, a substantial portion of our work is at government facilities. And so if there's a shutdown some agencies have been fine pivoting that work to get done remotely. Certainly, during COVID we saw some flexibility there. Typically, that's not possible with our Intel customers. And so that gets impacted. But usually, those customers don't get shut down. And the shutdown it really comes down to what is essential activities that have to continue to take place and so we've been fortunate that a lot of the work that we do, most of the work that we do is deemed to be essential. And so it's kind of continuity of operations there. And so that's the work that we want to do now is to make sure we're looking at a scenario where that were to take place, how do we assess the contracts that we're performing on as essential or nonessential. How do you have that dialogue with your customer early, your corresponding contract officer to get their point of view to make sure we're aligned. If there's something they need to do to position that work as essential let's get started on that, right? So that's the best case scenario is that you're not disruptive and on the ones that are disruptive, if you can't report to work, customer shops are shut down. We have avenues. We call it administrative absences kind of like, "Hey, we'll put you on an overhead charge number for a period of time. And when you're back to business, we'll let you make up that time kind of working a little bit over time and kind of pay that off." We've been successful in doing that in the past, and that's why we've really mitigated any substantial financial impacts associated with the shutdown. But each one is different, and so you have to be prepared for those scenarios.

Right. Okay. Stepping back, I think you said 2021 that you had your Investor Day in the fall. Getting better keeping all these numbers straight. Yes. At that point, I think you put out some longer-term growth rates for each of your end markets or segments and just give you an opportunity here to maybe chat a little bit about some of the puts and takes across that growth rate since then.

Well, I'd say in big picture terms, when we when it came out in October of '21, the overall budget environment that we saw ahead of us, we estimated it to be about 4.5%. And I would say, since that time, in the aggregate, it's looking better than that, right? The environment today has more robust budgets than that. So that's only improved. Now that's not exactly the case maybe in every subsegment of that market, but the health area has been strong and growing. Civil is probably done as well, if not better. I mean, with the exception of, hey, we still know the aviation security market is probably not where it could be from a budget growth perspective, but that will bounce back. And the DoD is more well-funded than expected. So the big picture backdrop looks as good or better and we put out a 5% to 6% 3-year growth target. We closed out the first year, right about 5%. We've got a little work to do to kind of get up in the middle or the high end of that range. But with the budget backdrop that right now looks solid in a number of programs that we've won on that are just getting started certainly in the early stages of what their growth cycles could look like such as the defense unclaimed services program or the reserve health readiness program, we like the growth trajectory that we see ahead of us over the next handful of years. And certainly, the Dynetics programs that we've been speaking about there, too.

Right. Perfect. Let's sneak in one last question on cash flows. So some moving pieces this year, obviously, for a lot of the reasons that you articulated on the most recent earnings call. As we look ahead past 2023, we've got some tailwinds going on. But I do want to give you an opportunity to talk about any potential headwinds that we may not be thinking about now. And the one that comes to mind potentially for me is some of the in-sourcing that you're doing on the manufacturing side. So maybe that's the only thing kind of comes to my mind potentially there, right because you got to bring in some inventory. But are there any other things out there that we should be thinking about?

Well, I mean, we'll evaluate that on an opportunity-by-opportunity basis. And I'd say our general business model is strong as it relates to cash conversion over any 3-year period of time, 100% of free cash flow, 100% of adjusted net income converted to free cash flow. And we've demonstrated that looking back in the last 3 years. And last year, on a stand-alone basis, we are in the 94%, 95% range, right? As you go after some larger programs, as you go after some different programs, sometimes there is an upfront investment to outfit a customer's environment on IT basis or if we do work with utilities and industrial customers on energy efficiency work and sometimes you're outfitting an organization with modern equipment and then receiving a payback over time. I wouldn't say there's any particular headwind looking ahead. Obviously, we're coming off of this change in tax policy with the capitalization of research and development. That's a near-term headwind. But next year, it will be a tailwind. And then we're constantly looking for how do we squeeze more days out of our receivables and optimize on payables. What you mentioned on the in-sourcing of the security products business, I'd call that a modest investment. I mean there definitely will be $10 million, $20 million of inventory buys as we transition to be able to produce in-house not hundreds of millions of dollars, right? And even what we're doing on the airborne ISR space with some airborne assets, very affordable within the context of the 1% to 1.5% of revenue spent on CapEx. I'd leave you with is we're very thoughtful around making sure that those investments do generate a strong return. As we're finding those opportunities is through a lens of, hey, is that the best use of capital can we get above our weighted average cost of capital on a return basis. And if so, we think it's a good decision to make.

Yes. Great as a Californian and I appreciate the work that you guys are doing for PG&E to keep us from having 4 fires that will be nice. With that, we've run out of time. I want to graciously thank you for joining us today. It's a pleasure having you here.

It's a pleasure.

Thanks so much. That's it. Thanks for being great.

I appreciate it.