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

Great. Thanks to everybody for rejoining us here. I'm Joe DeNardi. I cover aerospace, defense, government services, airlines for Stifel. I think this is the last meeting of the day for everybody. So thank you to Chris and the rest of the Leidos team. And Stuart Davis, always it's great to have him back in the industry. But Chris, thank you for taking the time with us this afternoon.

Happy to be here, Joe. Thanks for having us. Look forward to the discussion.

Yes. And folks that are listening in or watching us on the webcast, if you all have questions, you want to get answered, feel free to use the Q&A function in the Wall Street webcasting app or send me an e-mail at [email protected], and we encourage participation and we track it, so ask away.

Chris, your -- I guess, in your new role in a month or so, can you talk a little bit about the opportunities you see as CFO? Maybe kind of your background a little bit within Leidos? What the biggest opportunities, challenges you see facing the company over the next couple of years?

Thanks for that, Joe. Yes. So a few short weeks away, right at the beginning of July, I'll take over as the CFO here for Leidos. Obviously, thrilled for that opportunity. I've been with the company for 22 years now in a variety of capacities. So having seen a lot of things from the ground up, both from a corporate finance perspective, treasury, M&A, accounting, but also 9 years in the business, focusing a lot on our civilian agency, our health businesses. So been in the middle of winning work and executing work for customers. And what I see, I mean, first of all, Jim Reagan has done a great job of building a first-class finance team. We're set up for success. We're pivoting to growth. In the near term, the priorities will be -- we've got a lot of work ahead of us just to continue to deliver on that growth trajectory this year. 10% organic growth is our guidance for the year and that's our expectation. We had a nice first quarter. So keeping that up and executing on the contracts that we won or expect to win is top priority. Number two, the integrations. We've done 4 acquisitions in the last 15 months. Not insignificant just to make sure that those get integrated into the business in a way that delivers the value that we expect from those companies, and we can really maximize the synergies across the company. So the integration work that's ahead of us is still really important. We've made a lot of great progress there, more to come. Thirdly, coming out of COVID, there's obviously a lot of lessons learned, some good, some bad. But really on the good side, where are the opportunities to continue to sustain the efficiencies we've realized that have helped us deliver strong margins and margin growth, certainly on the facility footprint front and how do we continue to evolve more towards a mobile workforce. So we'll be putting a lot of energy into rationalizing that footprint, driving long-term savings in the business. And then lastly, I'd say just executing on our strategic plan. This is the time of the year in the summer where we do a refresh of our strategy every year. We spend time with our Board of Directors. And then out of that, making sure that when we go into our plan setting for '22, we're really driving our investments and our discretionary resources into the areas that can deliver the most significant return. So that will be an important initiative in the fall. But again, I feel like we're really set up for success with a great team, good momentum in the business and not a lot of things that really need fixing, right? It's continuing that trajectory.

So Chris, when you look back, it's been, I guess, a choppy couple of quarters for the industry in general and for you to some extent. When you look at some of the variables that have been impacting the business between COVID and air traffic, I mean how is that starting to come back relative to plan? COVID seems to be a very fluid situation. So how have things been kind of progressing over the last couple of months?

Sure. COVID, obviously, it's hit different businesses in different ways. Our diversity, we saw a few impacts in areas that maybe certain other competitors might not have a position in. The 3 primary areas where the business was impacted -- you mentioned air travel. So our security products business in the aviation market, we did an acquisition kind of right when COVID was picking up. Unfortunately, the timing was tough. But that aviation market internationally still probably hasn't rebounded. So we've got some work ahead of us there to get that all the way back. But a couple of the other areas that were impacted, I would say, have rebounded nicely. We have a medical examination business for the Veterans Benefits Administration. And during the middle of COVID, the opportunity to serve those veterans was not there for in-person examinations. That has been reopened and that business is performing very well and actually working at an all-time high clip to work down the backlog of demand that we have there. And so that will continue for the next several quarters, we believe. And then the other big area that impacted many was in our intelligence business. When you have to work in a classified environment in a [indiscernible] space and there's only so much you can do to accommodate physical distancing and the work has to be done in person, that did suffer an impact. That was not overly material to us. It hurt us probably more on the margin front and the revenue front because some legislation helped contractors there. But we're seeing that almost all the way back -- not quite, but almost all the way back. So other than that, the business has actually been quite resilient. We've been able to drive through COVID with minimal impacts elsewhere. And now that we're into '21, our first quarter, we did 9% organic growth. We've won some new contracts. We're seeing other things ramp up and get started. So we feel pretty good that we're back on the right trajectory. Again, there'll be a few isolated pockets that we'll deal with over a longer period of time like aviation. But the only other thing that we saw, some people have talked about some procurement delays, and we've seen some of that, not a lot of that. I would say that the procurement cycle, certain things are taking a little bit longer to go from a draft RFP to a final RFP or you'll respond to a proposal and the customer will have several evaluation notifications, so it will extend the decision-making process longer than we've seen in the past. That's happened in certain spots. But generally speaking, book-to-bill was good in the first quarter. Our pipeline is robust. The activity that's getting bid on has been nice. So we're feeling pretty good that we've turned the corner from the challenges of last year from COVID.

Okay. That's great. You mentioned earlier kind of the strategic review that goes on this time of the year and I guess the role that, that plays in where you invest within the business. Like practically speaking, what does that mean? Does that mean you focus more dollars from a bid and proposal standpoint on certain markets? Or is it hiring or M&A? Like how do you -- what do you mean when you say kind of investment?

Yes, it could be all of those things. I mean, most notably our research and development budget. So I mean a good thing about our size and scale is we put a lot of dollars into research and development every year and that continues to be an ongoing priority. So where do we see the technical capabilities going? How do we continue to mature those? How do we put more resources behind that? Then people, right? So if you need more technical-oriented SMEs, solution architects, maybe you need more business development resources and a particular set of customer accounts, that will be informed by that process. And then you mentioned M&A. So right, if we're -- if we see as part of our strategic process, markets that we want to continue to grow, opportunities that are emerging, and there are capabilities that are needed to drive differentiation because that's how we like to compete, and we will do an evaluation. Is that something we already have? Is that something we could build? Or is that something that we're going to need to augment with M&A given the timing and the robustness of the demand over time? So all of those things are outputs of that process.

Okay. And you talked about, I guess, the focus at least initially on integration and, yes, making sure kind of you digest what you've acquired over the past couple of years. Can you continue to be acquisitive over the next 12 to 18 months? Or do you need to take a pause to integrate what you've already acquired?

Well, I mean, I would say we're never out of the market, right? I mean the preference is let's make sure we don't stretch our resources too thin. But from a financial capacity perspective, we have the wherewithal to stay in the M&A game. We've got an M&A team. We're always evaluating opportunities that are out there. So you never say never. I would expect, though, in the near term, if we did anything, it would be on the smaller scale, right, versus biting off something more sizable. If we get ahead to '22 and more of the integration work is in the rear-view mirror and we've gotten closer to our long-term leverage targets, that's when you might see us be a little bit more active potentially. But only based on the needs, the availability and the pricing, a lot of things have to come together to make it work out. But I'd say in the near term, I wouldn't expect anything on the larger size just because of there's only so much that you can do well while you're integrating 4 other companies.

Okay. And you talked about kind of the low double-digit organic growth that you're seeing this year. Obviously, some of that will continue into next year. And then I would imagine the airport business continues to be a tailwind for you over the next couple of years as that recovers. So maybe talk about it, if you don't want to talk about kind of an organic growth expectation beyond '21, like how you see your addressable markets growing beyond this year relative to the budget environment, relative to maybe some of the factors affecting the health business as well as what was maybe a pretty supportive budget on the Fed Civ side?

Well, absolutely. I'd say the budget itself we think is favorable. We generally like what's there. We think that we've got a lot of capabilities to help support civilian agency customers and health customers as they get additional resources coming out of the President's budget as that works its way through the process and turns into law ultimately, and it will evolve. But a lot of IT modernization, potential infrastructure modernization, areas that we do think our security products business will have a role to play in that too as spending becomes more clear. So like where the budget is going on that side. And then on the DoD side, which is not as robust in the near term, in the areas that we're more concentrated, we feel good about that. The RDT&E side looks favorable and the acquisition that we did of Dynetics a year ago, a lot of their programs are focused on RDT&E dollars and hypersonics, programs like that, some munitions programs, directed energy, things like that, that we feel really good about, cyber. So I think the budget -- foundationally, the budget shapes up nicely in the near term to be not a headwind on growth but to help support what we see. Last time we talked of longer term was 2 years ago, and we said 5% organic growth was kind of our expectation. We'll refresh that view again when we get to the fall. We'll have an Investor Day in October, so we'll talk more in detail about it. But that was kind of foundational and then you talk about the other things that are going on, right? We've won some larger programs. We're bidding on some larger programs. We'll still have some ramp-up on programs we've already won in NGEN and another program called Military and Family Life Counseling and health. So in '22, we'll have some additional growth from those programs. So I think things are shaping up nicely for us to be able to execute at that mid-single digits or higher is depending upon how these programs get decided. And then you mentioned aviation. It's a little unclear about when that will become a tailwind. Our view right now is probably -- that will probably take through '22 for -- especially the international side to come back and create some demand. So maybe we're looking ahead into '23 before that really picks up a lot of steam. But it's at a lower clip than we'd like it right now, but that's fully in our guidance. And so at some point, we do like the prospects of that bouncing back and being a better growth catalyst for us, but that's not here yet.

Okay. So is that your expectation with that portion of the business that it doesn't recover maybe in line with global airline capacity, that there's a lag between that and I guess when these airports start to procure equipment?

Right. I mean especially, most of the international customer sets that we deal with, they're funding new procurement buys by ticket surcharges, right? So they're going to want to see that the demand is absolutely back. They're going to want to make sure that, that can be sustained. There's no risk before they make major procurement decisions, generally speaking, not in every case. So we just think that will take some time. Maybe we'll start to see some things later part of next year, but our general working assumption is it's a little bit longer, even though the U.S. market has bounced back more quickly. The spending decisions here aren't really driven by passenger travel as much as obviously just budget -- procurement decisions and what happens with TSA and CBP and things like that. So those can certainly bounce back more quickly as far as demand goes there. But internationally, we think it will take a little longer.

Okay. You talked about kind of the prior base case being mid-single-digit type revenue growth and then kind of, I guess, updating that this fall some time. So when you think about maybe the moving pieces between the prior or the current goal and what the next goal could be, maybe the defense budget is somewhat less favorable for you all. The civilian side is maybe about the same thing. But over the last couple of years, you've proven that you can win more work and take share. And so why shouldn't the expectation be that you can kind of grow faster than that 5% over the next few years? Yes.

No, that's fair. I would say that, absolutely, that's how we like to think about it ourselves and challenge ourselves. We know that every procurement is a dog fight, right? But we've got a great process, we've got a great team. And we think that the combination of writing compelling proposals with technical discriminators that we continue to invest in with competitive pricing, always it makes us a strong competitor. And like I said, some of the larger opportunities that we'll go after, the number of viable competitors for some of those mega procurements, just -- there's only a couple to have the past performance qualifications to bid on an opportunity like a Defense Enclave Services coming out of the DoD DISA agency. So you're right, Joe. I think that we always -- we have been punching above our weight. We have been winning more than our share. That's something we'll challenge the team to continue to do. And you'll see. You're seeing other competitors make moves in the space, making acquisitions, trying to build concentrations in areas they were less penetrated in. So we recognize that the competition is always evolving and getting stronger as well, right? So we've got to be on our A game.

Okay. I mean, Chris, is the DISA Enclave contract, is that like the one contract in your office on the whiteboard with a big bull's-eye on it? Or are there other ones ahead of that?

Well, no, I mean, there's -- if you go down to our proposal pits and our headquarters here on 5, there's a -- teams are busy working on a number of large opportunities. But that's clearly the leader. There's nothing else even close to that size and scale. But there are several north of $1 billion opportunities that we've bid on. We've talked before publicly about one with the NGA called UDS. A lot of that is work that we already have, but they're consolidating some additional work into that vehicle, and that's multibillion dollars, and we expect that decision sometime later this year. There's a big network modification job for the FAA called FENS, and we've made no secret that we're a bidder on that. We think we're viable. The competition is tough. NASA has got a major procurement coming up that is a takeaway opportunity for us, multibillion dollars. So there's several that are on the hit list in the corner office that even Roger knows by name and is focused on, he's probably done a wall walk or 2 where he gets down in the proposal pit, and we go through the win themes and look at the details of the pricing. So it's all hands on deck for the big ones.

What's the timing on Enclave? Is that this year or next year?

Publicly, they've said it could be a fourth quarter decision. I think that, that seems somewhat aggressive. We'll see. Or if it happens in the fourth quarter, you always have to anticipate for a deal of that size and scale, there could potentially be a protest. But late this year or into the first part of next year is the current thinking on that.

Does winning something like NGEN make it easier or harder to win another, like, mega contract like that? I mean obviously, you've got -- I would imagine the past performance is beneficial for you all. But at some point, does it become -- I don't know, share the wealth a little bit? Is that ever a factor in it?

Yes. I mean, I think -- and obviously, this is a different agency. The Navy made the decision on the NGEN program. This is DISA. I would say certain customers might be a little bit sensitive to major concentrations with a particular contractor. We don't see that as an issue right now with DES. But it's always something you have to be aware of. And that's when you think about M&A, you look for where do you have a lot of overlap and you don't need to be too highly penetrated in a particular area that could be vulnerable for attack in the future. But I -- we don't see that, that will factor in the decision-making on DES. We hope to past performance and qualifications and compelling proposal, how are you really going to deliver the modernization they need, the transition to an integrated network environment, be able to operate that effectively on time, on budget. Those are the kinds of things that we're trying to make sure that our case is very compelling around.

Okay. And then maybe kind of higher level, if you go back 3 or 4 years, there was a lot of focus within Leidos on proving the strategy that scale could be a competitive advantage. And then you followed that up with pretty strong 2-year run of winning more than your fair share of work and that's translating into an industry-leading organic growth this year. When you look at the pipeline of opportunities over the next couple of years, is there kind of a, I don't know, similarly compelling opportunity for you all to maybe do what you did a couple of years ago? Or was that more of an anomaly? And the bar -- the expectations bar that we should have for you all is lower than that?

Is from a winning based on our size and scale, the book-to-bill that we were able to print, is that where you're going, Joe?

Yes. Yes. The opportunity set just in general, it sounds like with some of the contracts that you're pursuing, is it similarly strong as what you saw a couple of years ago?

Well, I think that it is. I mean that was somewhat unique that there were a couple -- there were 2 franchise recompetes that were in there, and then the Navy NextGen takeaway. So they don't always line up where you've got 3 that are north of $5 billion kind of like what that suite of opportunities was. But there's DES and then there's several that are in the $1 billion to $2 billion range. I would say, generally speaking, our pipeline is as strong as it's been. The volume of submits that we'll have going in this year is as high as last year, and those were record-high levels. So we still -- we're not seeing a shortage of things that we can bid on anytime soon. But yes, running the table like that is hard to do, and we don't expect to do that. And when you do it, that's fantastic. But as long as we can -- the good news is the multibillion-dollar opportunities we're going after right now, other than the one UDS one that I talked about, which is kind of mostly a recompete but not all, these are all new work or takeaway, right? So you're not going to hit at a massive win rate, but anything you win is incremental as growth, it moves the needle of size and scale. So again, I think that we're set up for a potentially robust bookings performance, more likely as it gets into '22 as those things settle out, but perhaps even the tail end of this year, we'll see some of those decisions get made.

Okay. So it sounds like kind of the opportunity for you all is maybe as robust as it was a couple of years ago. But assuming that you all can win as much as you did then is an optimistic scenario, optimistic outcome.

Right. I mean I would just say that, that doesn't -- if you look at trends over time, in the industry, people are focused on winning their recompetes and you would expect to have a high win rate on recompetes. So takeaways, we've done great, we've done better than average. I think Roy Stevens, the Head of our BD team, would tell you, winning at 50% or higher on takeaways, that's not sustainable long term. But we approach everyone with the same vigor, the same attention to detail, the same aggressiveness on making a compelling case on pricing. So we go after everyone with putting the high-quality proposals forward, and we'll see how the chips fall. But clearly, we're not counting on running the table in order to drive the growth that we're talking about today.

Okay. And then we've got a question from the audience. What is the normalized growth in your health business without the impact of COVID? Would health revenue actually be at a lower run rate in '21 due to the pent-up demand impact?

Well, we don't guide by segment. I would say that the pent-up demand is helping drive some growth this year, but really more growth is going to be coming from a couple of key programs that we've won that are new. The Military and Family Life Counseling Program, that's a $1 billion program. We're in year 1 of that. We're just getting started and ramped up. That's a big growth catalyst. We've continued to grow our Defense Health modernization program with additional rollout to additional locations within the DoD, the military health agency. So that's driving growth on the DHMSM program. And then we've got another program called Reserve Health Readiness, which has been -- we won it. It was in protest. That finally appears to be breaking free, and that will be a program that starts to get ramped up over the back half of the year. So there's a lot of great things going on in health other than just our -- the backlog of demand in the pent-up Veterans Benefits program, but that is helping. But that's not the only thing going on driving growth there.

Okay. How long does DHMSM take to get ramped up do you think?

Well, I would say that probably we might see a little bit more ramp-up in '22, but '22 will be modest growth compared to this year is the current expectation because other than a little bit of delay in the first quarter, we're kind of now operating in a -- we've got several waves of deployment ahead of us, and those will go in sequence, and we're doing multiple waves at a time. So a little bit more growth in '22 and then it kind of levels out through '22 and '23. All the deployments should be done as we head into fiscal '24.

Okay. And then the expectation on NGEN, is that -- that's kind of partially ramped up this year and then continues into next year?

Exactly. We just transitioned a major component of the staffing in May. So June, we'll start to see that pick up. And then there's another onboarding, a transition milestone that happens later in the summer. So whatever has contributed this year, definitely we'll get a full year of that run rate rather than 6 months. So it will be a nice contributor to growth in '22 as that program finally reaches its steady state.

And then, Chris, just on Dynetics, if you could just kind of update us on how that business is performing and then maybe the next major milestones or opportunities for them that are coming up.

Sure. Dynetics has been doing great. It has been in a heavy growth trajectory. You've seen that from some of our filings. Now they did benefit from working on the lunar lander program. So there was a 10-month $250 million contract. That's worked its way through for the most part, there's a little bit still to go there. And we weren't successful, but we're protesting, along with Blue Origin, the decision on the next phase of that program. That being said, the rest of the business has continued to drive growth. It was not very many like super mega programs to speak of that are hypersonics, our directed energy, our cyber work. Hypersonics specifically, there's -- a major growth opportunity is still ahead of us, right? As that program is ramping up into a production phase, where the prototypes are actually going to be manufactured. We've built a new facility on Huntsville, Alabama to be able to do that work. That's going live soon, right? So that will go into a production mode into '22 and '23. And there are some other opportunities we're bidding on as it relates to integrated force protection. I mentioned high energy. So again, a lot of -- what we've done with Dynetics, we've integrated our legacy R&D engine, we called it LInC, Leidos Innovation Center, underneath Dynetics leadership. That's kind of the front-end idea generators working with customers on, whether it's DARPA or Air Force Research Laboratory, what are the next things that are needed and then how do you take that through a process to mature that into major programs and opportunities. And the last thing we've done with Dynetics that I would speak about is we did the Gibbs & Cox acquisition. That closed in May. We've integrated that with the rest of our Maritime -- legacy Maritime business and put both those pieces together with Dynetics leadership. So we see a lot of synergy opportunities driving that into Dynetics in their portfolio. And so we're very bullish on the prospects that can emerge from those operations here over time.

Okay. And then maybe just lastly on margins, the margin profile of the business, you've done a nice job in the past couple of years. Margin expansion adjusting for some of the anomalies, I guess, going forward, do you still see the opportunity for kind of year-over-year margin improvement? Or at some point, does that become dependent more on kind of specific contracts and shifting contract mix?

Well, there'll always be some element of what types of contract you're entering into, the mega contracts and the ramp-up. But I would say, across the business, as we've grown and we integrate these acquisitions, that helps us drive some more efficiencies. We talked earlier about COVID. And one of the things that we still have ahead of us is rationalizing more of our facility footprint, taking cost out of the equation longer term because that hasn't been realized yet. That will help the cost structure of the business. And we'll decide how much of that do we want to reinvest in building out additional capabilities on the technical side versus how much of that can just drive margin improvement opportunities. So I don't think we're tapped out of areas that we can explore. Again, as we win these larger programs, we like to find opportunities to drive to fixed price in T&M where we can and take a little bit of risk. But as we deliver effectively, have more rewards. So that's all part of the profile. And certainly, in our civilian agency and health customer set, we tend to see more contracting like that. So that bodes well as we see more opportunities in those spaces here going forward.

Okay. Well, I will make sure everybody stays on time and leave it there. Chris, thank you for taking the time with us, and thank you all for participating.

Joe, thanks for having me. Pleasure to be here today. Thank you so much.

Take care.

Bye.