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

Got it. Okay. So is there a trend? I mean you're mentioning this as sort of an expanded recompete. It looks like a lot of the big awards that are out there are kind of -- they're big awards and they're expanded and there are kind of fewer players as a result of that. Is that a trend? Do you think that trend is going to continue?

Well, we've talked about this obviously for years. And just about the time I say, well, we're seeing aggregation of contracts by organizations like DISA and their Defense Enclave Services or the FAA and their services. And as soon as I say that, then another customer will do some disaggregation because they want more competition. But it does feel like right now, there are more of these aggregation multibillion-dollar opportunities in the digital transformation space than there maybe were 2 or 3 years ago. But it raises the strategic importance of winning. But I would also submit, it reduces the competition. But it only takes 2 bidders to have a competition. And there are enough qualified bidders out there that all of these awards are highly competed for.

So can you give us some color on new business potential in '21? Any big opportunities in the enterprise IT space like Enclave, and I think there's a down-select too on Lunar lander coming up? Anything you can feel comfortable talking about in terms of new business?

Yes. Well, the Defense Enclave Services, which is a DISA program, was due this week. It is the consolidation of a lot of services and DISA providing services to the other services. It is a significant program in the multiple -- high multiple billions of dollars. And then that will work its way through the procurement process, like everything else. And although there's maybe a chance that it could be decided this year, but it's likely to be protested. So it's going to be '22 before we know for sure. There's a couple -- there's a DHS cloud center optimization program that's also in the mid-single-digit billions, which is a DHS program. And then I'll talk a little bit about lander. We're a base phase participant. There are 3 companies that are participating in that. We are in the month of finishing our PDR, our preliminary design review. We have submitted our next phase proposal, so this would be an exercised option on the contract that we have, what we call, option A. We just contemplated that they will down-select from 3 to a smaller number. We're thinking they'll go from 3 to 2. Originally, it was contemplated that they would make a decision before the end of this month. We have been asked to extend our period of performance for a short period of time, and that's to continue to make us and the other contractors awardable for an option on the base contract. So we expect probably in the next 6 to 8 weeks, they will make a down-select. And then it's going to be what was in the budget, what can be spent, but it is -- would be a contract to build a lander and conduct a test mission. So it's a sizable contract for us. And everyone here is really excited about the human space program and the return to the moon. And we would be thrilled to be able to receive an option A award. And it would be a significant award for us, clearly in the billions.

So I think somewhere I read there was -- I don't know who did the review of the 3 teams. And you guys, to my surprise, I think you won -- you may not have won every single item, but you certainly won a lot of them. So -- but on the negative side, I think Congress cut the money for Lunar lander. So if you win and if we go to 2, does this business continue to get bigger for you over '21 and '22? Or are we kind of at a plateau because it's already been fairly big?

If we win, we win the option A and the lander program, this business would grow significantly over what we have in the base contract. Now like many things, I think there's a '21 funding challenge over what the President -- both the prior President asked for and what is in the budget. But remember, if we get an award in April, we start to ramp up. The end of the fiscal year is September, so it's only 4 or 5 months. And it's really going to be about what money they get in the next year and the year beyond. And I don't want to speak for the customer, but I suspect that the Biden administration is looking at the schedule. The Trump administration was very focused on landing the first woman and the next man on the moon before the end of his second term. And one might anticipate that the Biden administration will revisit that time line. And when they do that, that will change the funding profile. And we will do whatever our customer asks us to do relative to the base A contract.

Got it. So buying Dynetics, L-3 Security, they were your first product-oriented deals. Do you see doing more? And how do products fit into your vision of where Leidos is headed?

We've -- services, solutions, products, those have always been words I know that others like because then you fit into some existing categories. We don't really look at life that way, but we know we have to speak in the language that you want to hear. And so let me answer your question, and I'm going to tell you why I think the question is different. We like the work that we do in a virtual world, we like the information technology work, we like the science that we do, and we like building things, right? So -- but the items that we build, if you call it a product, complement a customer's mission. And so that's really how we think about life. By the way, we build software, but we don't look at software as a product. But we do that. We cut code. We do a lot of python. We do a lot of AI/ML and software, but nobody views that as a product in our world, we have software factories that build software, and we provide that software to customers, but that's not a product. So -- but yes, we're very comfortable with having more in our portfolio that is something physical that you can pick up, whether it be a radio or a sensor and, on occasion, an entire platform, whether it be an autonomous ship, like Sea Hunter, or the Human Lander or the Gremlins unmanned vehicle that we're testing out of the Dynetics group. We're very, very comfortable with that. But our view of the market starts with a customer with a mission that they have to get done. And we want to add capability to the company that allows us to address their mission in an innovative and technically differentiated way. And if we own more of some of the product, like the software programmable radio that we have for a cooperative engagement system for the Navy, then we can better provide a point of difference in the mission because we own the entire value stream. Now we don't -- we're not going to be in the shipyard business. We're not going to have a tank plant. We're not going to have an aircraft plant. That is not our business model. Our business model is to be very, very asset-light. And where there is an excess production capacity in the world, like in, I would say, in shipyards today, and we get access to state-of-the-art shipbuilding, we are going to partner with others. But we're very, very comfortable in continuing with a acquisition like 1901, which was really around digital transformation and IT as a service and edge to cloud, and on occasion buying companies that have more involvement with a physical product.

So a lot of your peers tend to look at M&A as a way to increase their capability set to increase their access to desirable customers where they don't have positions today. As you think about your business, are there any areas there, either customers you'd like to do more business with or capabilities you would like to bulk up to be more competitive?

Yes, Cai, there always is. So our process, which we would like everyone to understand, is highly disciplined. And so we have, like everyone else, an annual planning process where we start just about now. We look at what's going on in the customer space, the President's budget, priorities. And we build our strategy, and we rebuild it every year on an annual basis. So we look at what has changed in the marketplace. For instance, we're really looking hard at the new administration and health care and civil infrastructure. And then from that, we build sub plans, and we look at where we think the customer's mission is going to go, where their spending is going to go, and we look at our sub plans and our competitiveness and we look at our technology road maps and the core capabilities that we have within the company and we identify gaps. And we say, we need more capability in hypersonics, AI/ML, electronics. And then we go through sort of a make and buy process. We prioritize our R&D spend so that we're spending our R&D to fill our gaps. And then we also look for opportunities in the M&A market to fill our gaps. And there are times where we have enough, if you will, time to develop a technology internally and we have the right people and we have the right assets. And then there are others where it's just going to take too long for us to develop that capability or to develop the market access, and for those we prioritize M&A. But we're very, very disciplined. We have an organization that's connected to our strategy group that does this very, very well. We do have a pipeline of companies. Long before they ever decide that they want to have a liquidity event, we are working with these companies. And very often, and this was true in the case of Dynetics, it was certainly true in 1901, we have had years of partnership work with the company. And we might be prime, they may be a sub. I think in the case of Dynetics and 1901, it was both. They were prime on some, we were prime on some. And that way we get to know their culture, their management, and we get very, very comfortable that if they were to become part of the Leidos family, the business would continue to grow and to be a success.

So your debt ratio came down in 2020. When will you be ready for transactions larger than 1901? And maybe give us some color on your relative priorities between M&A, between repo, between dividend hike?

Well, we could do -- we can do $1 billion deal today. The cost of debt, interest rates are historically low. We're not afraid of leverage. We would want to get back to 3x after doing a big deal. We -- and we all do the same maps of the industries, and there's just not much that I see that is on the market or it would come on the market that would drive us to do a multibillion-dollar deal. Not saying we never would. I don't want to do an absolute. But it's really not where our thinking is. And so what that really comes back to is the capital deployment priorities that we have been reciting on our earnings call, gosh, it must be 4 or 5 years, which is we want to make sure that we spend enough money internally in research and development, specialized test equipment, capital where it makes sense to enhance mission and profitability. Once we do that, we are a dividend payer. We're going to continue with the dividend. And then we look at both share buybacks and reducing the debt. We're in a wonderful situation where most of our debt now is fixed, and we have what we think is a very enviable all-in interest rate. So I don't really see that we're going to do a lot from a deleveraging standpoint. So M&A is part of that investing internally, and so that will be one of the places we deploy capital. But our asset-light business model is going to create opportunities for excess cash. And in the past, we have raised the dividend. We have done accelerated share repurchases. We have done open market purchases. We have done special dividends. And those are all things that we consider with our Board of Directors 4 times a year with our Audit and Finance Committee. And we will think about that at the next Audit and Finance Committee.

So I take it -- when you bought IS&GS, you said this was the key to success, gave you diversity and basically gave you scale. And you've been one of the key proponents of you need scale to win. You certainly have scale. Do you feel, with what competitors are doing, you'd like to have a little bit more? It sounds like if you're -- no multibillion-dollar deals, you feel you're fine in terms of scale.

I get this question a lot, and the headline answer is we're very comfortable with our size and the portfolio that we have. And we are somewhat -- I think we pause and we smile a little bit when the rest of the industry, who, by the way, when we did IS&GS, many people came out and said, well, scale doesn't matter in this market. But if we look at the history, we did that deal in summer of '16. So we've got 4 years. There's been significant consolidation to scale in the industry sort of behind our deal. So we think our thesis really was correct. And we're especially as of late, in the way we've been able to win new business organically, seeing the benefit of that scale. But to give you the specific answer is I think we're okay with overall corporate size, but there are clearly markets, right, that we would like to have a bigger presence. And we're not going to go through all of them, but we have scale, say, in DoD. If we start to disaggregate that, there are clearly markets maybe in space, maybe in other areas that scale. We don't think we are where we need to be. And so there are acquisitions. Again, it doesn't have to be in the $1 billion range, Cai, but -- and complementary acquisitions, still things that we would like to do.

So Roger, you're, having come from the primes, one of the few guys who saw the whole process of consolidation there. I was talking about it with someone the other day, and really, if you stood back, the idea was the guys who really moved, Northrop and Lockheed, ended up being winners. GD took sort of a little different strategy in just focusing on areas. And guys who thought they were okay, Boeing and, I don't know, Raytheon, ended up being disadvantaged. So really -- and it looks sort of, with low interest rates, that this is an industry where we're going through a consolidation process. Do you feel the winners are going to be the folks who really kind of figure out where they need to go and are relatively aggressive in doing the deals? Or can you kind of sit back and play the hand that you have?

Well, for us, now is not a time to become risk-averse, right? I think about that and certainly coming out of IS&GS, it was -- and we took a year or 2 to make sure we got merger integration correct, and I think it took us a year or 2. And then it was, okay, we're in this, I think, a good position, what do -- how do we take our market position and continue to grow? And there are some days where, I think, no, you've still got to lean forward, you've still got to think about what should you be doing in the marketplace. We're clearly not a niche player. We are a broad multi-market player, and therefore, we ascribe more, Cai, to the, no, I think you need to continue to grow and to win and to think about new markets, and some international, and to grow share. There is always room for a company that wants to be a niche player who's going to be very, very, very good at something that's relatively narrow, and they can focus on a couple of capabilities or a couple of customers, and they probably can exist. There is some vulnerability, perhaps. Sometimes their ownership is such that they're not vulnerable. But I can just tell you, for us, we want to continue to grow. We want to continue to expand our capabilities. We want to add to our technical differentiation. And so at where we are finishing the year, what -- we'll tell you about guidance on the earnings call, that's certainly not the end. That's just another stepping stone in our journey to being the company that we can be.

Terrific. Well, this has been really interesting, Roger. Greatly appreciated. I see from our monitor that we are running out of time. So anyway, thank you for doing this, and have a great day.

Great. Cai, thanks. It was great to get together. And I saw a tagline, I thought it was really good. It's: think positive, test negative.

Good idea, good idea. Terrific. Thanks so much.

Great. Thank you.