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

So it says we're live, sorry, for all you watchers out there that we have been a few minutes late here. This is due to some technical difficulties that we had no control over. My name is Craig Oxman. I'm Vice Chairman and Head of Credit Suisse's Aerospace and Defense Group. And I have the pleasure this afternoon of introducing Chris Cage, the Chief Financial Officer of Leidos. And Chris, thank you for joining us. And I think this is not the first time Leidos has joined us, and we're really glad to have Leidos back with us.

So thanks for having me, Craig. Look forward to it. Appreciate it.

And what I might like to say is the housekeeping matter is, should anybody have any questions that they would like Chris to answer, please find my e-mail address somewhere on the Zoom system. It's craig.oxman@credit_suisse.com. Hyphen is extremely important and send me the message and I will relay it to Chris.

So with that, Chris, and mindful of fact that we don't want to overrun our time, which was already cut short a little bit. Maybe if you could just talk in an open-ended way about how you see Leidos' value proposition to investors? In other words, if a person were to wander into the story for the first time, what would be the first 2 or 3 things that you would want that person to know as to why to invest in Leidos?

Well, thanks for the question, Craig. And I would say that, obviously, Leidos predominantly in the government services space, but we built a portfolio in the company that's much broader than that. I mean, I think, if you look at our lines of business between Defense Solutions, Civil and Health, we serve a lot of critical missions to a lot of important customers and through acquisitions and internally developed capability, we've really got proprietary offerings, technical differentiation that helps us stand out from our competition. We're the largest pure-play competitor in our space, over $13 billion in revenue. And that scale and that technical differentiation continues to help us stand out and compete for the most important, most impactful initiatives within our services segment customer space from digital modernization, cyber and with acquisitions like Dynetics that we recently acquired into program areas such as hypersonics, critical areas for the Department of Defense. So we think we're in important mission areas with important customers, and have the size and scale and technical differentiation to really stand out and continue to grow at a pace above our competition.

So you talked a little bit about scale, and this is a subject that is frequently debated. How should one think about scale in this business? Does it matter? At what point does it matter? At what point doesn't it matter? And who really cares about it?

Well, I'd say it depends on what you're going after. So if you want to be a credible bidder on some of the mega contracts that the government lets out. So for example, last year, we won. And this year, we're executing on the Navy NextGen program, right, where we're providing the support to the Department of the Navy running their network worldwide. That is a massive contract. We run the DoD's network, GSM-O contract, right? So global in nature, hundreds of thousands of users, having the size and scale and capability and past performance to say, we're credible, you can count on us to execute at that scale. Not very many people have those qualifications to be a credible bidder to provide services like that. So it gets you in the door, right, at that kind of mega layer. Beyond that, I'd say what's important about the scale aspect is that it allows you, in this business, as a government contractor, there's a certain set of requirements and infrastructure that you have to have to compete that cost money. And you also want to continue to invest in your technical differentiators. Having that size and scale allows you to kind of over a larger base, spread those costs, make you more competitive, enable you to attract the best talent that wants to come work for a company that has a diversity of experiences that they could be involved in. So all of those factors, we believe, are benefits of having scale. I wouldn't tell you that more is always better, right, but the right scale with the right past performance and the right ability to kind of fund those important things to help you differentiate while maintaining a competitive posture are always valuable. And I think we've seen many people in our space try to replicate some of the moves that we've made to scale up.

Well, that's no doubt true. We've seen a lot of large-scale mergers over the last half-dozen or so years. When I think about when Leidos -- as Leidos was born, it was in the $5 billion revenue category, then the IS&GS deal kind of doubled that size and now you're getting closer to $15 billion. So how do you keep growth going once you get that big? Because the problem is now obviously 3x as hard to solve? Is it not in terms of future growth.

Well, that's true. The numbers get bigger, Craig, I mean -- and you're absolutely right. But I think it starts with making sure we're in the right market areas. Each of our individual lines of business were looking deep into their markets and making sure we understand what those prospects are. And we have 3 externally facing market segments. We have kind of 5 internal groups that operate at a senior level. And so they understand within their customer set what those opportunities are. And so we built a portfolio that we think is well positioned even in customers that will face more budgetary pressure, perhaps the DOD, for example, how we lined ourselves up to be in the critical mission areas. I mentioned hypersonic, indirect fire protection, high-energy laser. Those are some of the things that Dynetics is working on. We're in digital modernization, which many customers have modernization needs in their IT and network infrastructure, cyber protection, things like that. So being in the right place within the customer's mission set is critically important, but -- and you have to be positioned to go after those larger contract opportunities, and we have to continue to win our fair share of those to grow. And we have them.

We have a question here from the audience, and I'll paraphrase it as best I can. But the question has to do with what headwinds do you see that could slow the growth over the next year or so?

Well, so for us and specifically, some of the areas that we see as headwinds because we have some tailwinds, too. But -- and this impacts many contractors. Obviously, we were supporting certain missions in Afghanistan. The company was over there, whether it's ISR missions and other particular activities. That with the pullback and the drawdown in Afghanistan, will have an impact '21-'22, we'll have a lower run rate supporting some of those mission areas. That's an impact to us. That's an impact for others. Then we've got -- we were fortunate enough with our Dynetics acquisition to win a position on the Human Lander System Program base phase. We did great work. As they down-selected to the next phase, we weren't chosen that went to Elon Musk and his SpaceX, where they were bought in, if you will. So that's a headwind for us because it won't replicate. And then the last area for us that I'd point you to would be in our medical examination business. Obviously, in 2020, COVID happened, we were not able to fully support all of our customer mission areas. The Veterans Benefits exam area was one of those. And so that was depressed in '20. And in 2021, we work hard to make that work up, to work off that backlog. And so we were able to do that effectively, and that will not replicate in 2022. So those are company-specific headwinds. I mean, obviously, we need to get through some budgetary discussions in the government. The debt ceiling still has to be brokered. There will be bills to pay coming out of the COVID relief activities over time. But again, I'd point you back to the portfolio that we've built, the agencies we're in, the priority areas we're focused on. That's why when we did our Investor Day in October, we talked about a 3-year set of targets. We said 5% to 6% organic growth was our objective over that time horizon, and we still feel good about that. But those headwinds that I spoke about for 2022 are certainly some things will have to overcome in the near term.

That's very specific and definable as to the headwinds, but it's only fair to ask about the tailwinds as well. I mean what is it that you could see that could really surprise the upside or at least support the base case very, very securely.

Sure. So obviously, we're pleased that we had a strong set of wins going back a year plus ago that we're executing on. I mentioned the Navy NextGen program is the biggest of those opportunities. We had a great year this year. Our team did an exceptional job, really ramping that up. We have almost 4,000 people working on that contract. And so that has a lot more room to grow into 2022. So we -- because the second half of this year was really when we went full steam on that program. So we're excited about that. We won a couple of important programs in our health business, a Reserve Health Readiness Program, Military Family and Life Counseling Program. Those have been ramping, but there'll be incrementally more important and impactful in 2022. So we like the growth prospects there. We won unfortunately, it was protested. The big NASA job, IS&GS, the incumbent contractor protest, and we'll have to see how that plays out. But we were encouraged by NASA selecting us. That's a very large program of size, a couple of billion dollars. So things like that, coupled with the pipeline, it's a robust pipeline, not quite $40 billion of awards in customers' hands, awaiting decision timing. So it's competitive out there, but we like our positioning. We spend a lot of time on our proposals and are hopeful that we'll get some good news in the first part of 2022 to keep us on that growth trajectory.

Very good. So with all the large deals of 2020, and the accompanying debt, it seems to me that the mission has been pay down the debt, integrate the acquisitions and get all the goodness out of them. Can you kind of let us all hear what your current thoughts are and where you are in that whole process? I mean what inning are we in? What quarter are we in, in terms of the initial objective?

Yes. Probably it's deal by deal, you're right, Craig. We had a lot of activity in a relatively short period of time where we did 4 or 5 transactions now in less than a 2-year period. Some of which are, I would say, fully integrated or about to be. So we completed the second phase of our SD&A acquisition here in the fourth quarter. We will complete our 1901 integration in the end of the year, so first part of '22, that one should be integrated into our systems and kind of fully leverageable across the corporation. We did a transaction Gibbs & Cox earlier this year to enable the maritime architecture engineering space, which we really like the positioning that gives us longer term with our Navy customer. That one we will be doing most of the integration activity during 2022, but it's relatively straightforward, and we'll get that plugged in and up and running. And the Dynetics -- We've done -- we've integrated some aspects of Dynetics. Actually, we've done some reverse integration because the Dynetics leadership team has taken over some parts of our legacy portfolio because the synergies that existed there. So there's a lot of good things happening on the business side and then on the back office side, a little bit of a longer tail because of the manufacturing ecosystem to make sure we're making the right investments to both with them and the other manufacturing businesses that we have, that we've got the infrastructure in place to do that at the right size and scale with more state-of-the-art capacity. So that will be over the next 18 months or so, we'll complete the final steps in that integration. So we're feeling good about the progress. We've got a great team that's working on it. We know how to do integrations. It's easier to go buy things. Sometimes the hard work is after you acquire them. And the good news is we've got a lot of great staff that have built up a tremendous experience over the last several years doing that. So -- and then the other piece of that question, Craig, would be the debt side, and we are almost back to the leverage target that we set out. And we've shown that we can go above that leverage target and are willing to do so to acquire a company and to pay that back down. We'll complete the payoff of the financing we took out for Gibbs & Cox within the early part of 2022. And we continue to evaluate what's happening in the market. And if we see something that interests us, we would certainly take a hard look at it.

So with all the M&A activity, you guys must have become fairly expert on integration. So what are the main lessons learned from integration and going alongside that, what's the story on synergies imagined upfront versus actually achieved, how do you sort of think about that differently because of the experiences you've had?

Well, I would say that, I mean, first of all, with the integration side, have a plan running like a program, have a plan, have an integrated schedule, have a team, dedicated resources. All functions are represented, have the disciplined rhythms to report progress regularly up to the highest levels of the company. Roger and I still sit in integration review meetings on at least a monthly basis, if you will, and other teams are meeting certainly more frequently than that. So you've got to have that rigor and rhythm and management interest and engagement to make sure it stays on track because you're playing the long game at times, right? And so that's critically important. And then on the synergy side, I mean the same thing is true. I would say of the deals that we've done most recently, most of them were not focused on cost synergies per se. We always try to make them as efficient as possible. Going back 5 years ago when we did the IS&GS transaction, there was clearly a cost synergy value proposition. And we had to identify how we were going to take out hundreds of millions of dollars across different functions and execute that very deliberately, again, over a well-managed plan. The ones that we've done like Dynetics didn't have a cost synergy aspect to it. It clearly has some revenue synergy aspirations, 1901 more of, again, it's kind of introducing a new capability that we can leverage across multiple contracts to improve our profitability on service delivery. And then I would say, SD&A, clearly, there were some opportunities for some cost synergy because we had a legacy security products business in the ports and borders market predominantly. We acquired a company with an international footprint in the aviation security market. And so we are on that journey of rationalizing all of the first, the back office side, get them on the same systems, the same processes. And then the next frontier is how we deliver services across the globe, right? Because we've got people forward deployed in the right position to service the installed base that we have and optimizing that so they can service all the products that we offer will be the next frontier of synergies that we're able to capture. So again, I think we've demonstrated to ourselves and externally that we know how to execute that. We run it with a lot of discipline and rigor and having experienced people on the team that have taken part of that really makes an important difference as well.

So have there been areas where you've gotten more synergy than you expected or less synergy than you expected?

Well, I would tell you that the area that is always hardest to come by and you've got to have a long-game mentality on the revenue synergies. Realistically, when you're acquiring new capabilities or different customer access, Gibbs & Cox, for example, it's going to help us over time with our maritime autonomy strategy. And -- but again, it starts with making sure the business operates effectively, we don't disrupt that. How do we get more access to more customers, which turn into ideas and white papers and requirements and procurements, et cetera. So you got to have a reasonable point of view on what the period of time to recognize those synergies are, but you also want to make sure you've got people that understand is their responsibility to go execute on those. It can't be mysterious as far as who you're counting on to go deliver on the revenue synergy side. But, I mean, I think the cost side, it just comes back to how do we continue to leverage our shared service infrastructure that we built at Leidos and extend that more pervasively into the companies that we've acquired because all of those, whether it's HR services, procurement, accounting, those kinds of things can be delivered centrally, persistently, and that can help you rationalize a lot of costs out of the acquired company.

Okay. Switching gears a little bit. A good chunk of Leidos involves manufacturing, whether it's prototyping or even serious production. But how has the thinking about where and how to engage in that -- how is that thinking evolved over the last couple of years now with the experience of Dynetics and the experience of the detection business and so forth? You become -- even just with those 2, much more involved with making things. And those things have a trail of service that goes with them in many cases. But it's definitely more of a manufacturing emphasis than a pure services emphasis. And how has that sort of affected the thinking?

Well, I would say, I mean, first of all, we've always had some manufacturing in the portfolio. I mentioned we had a legacy security products, ports and border business. It wasn't insignificant and made products for CDP and TSA. We had other smaller manufacturing businesses sprinkled throughout the portfolio. I think what acquiring more mass in the manufacturing areas caused us to recognize that, again, we want to invest in certain tools to do that more consistently, how do we have better visibility and control over all aspects of the manufacturing life cycle, inventory management, shipping, receiving, all kinds of things like that. So there is -- there are some investments that we were planning, and we're executing to do that effectively. From a strategic point of view, it was really more of "hey, what are the mission areas that customers have", how are we -- how can we best serve them? And if we can serve them most effectively with product offering versus just a services offering, especially a product offering that's coupled with service that goes around it, that's where we want to be, and we think we've had success doing that this whole convergence, especially of hardware activities with data and information, the digital aspect and integrating that together is a strength of Leidos. So it's not like we had a set. We want to have this percentage of the portfolio be products, but it's been more of "hey, we have this today." We know what it's brought to the company. And we know the customers and the missions that they have, and we can do that effectively if we've got a little bit more technical discrimination that we can bring to bear in the form of products to those customers. And so we like how that's evolving. And like I said, bringing all of that together inside the company from a manufacturing ecosystem perspective will make us even that much more efficient.

Well, I would expect that now you're sort of a double threat, right? You can do the services and you can do the hardware and conversely, and not a lot of people can say that with a straight face in certain areas anyway. But speaking of new areas, one area where I'm wondering how much you are focused on. I know you already have some activity in -- I'm talking about space and particularly new space. You have some activities going on there. But how do you sort of view that as a growth area or not for Leidos in the coming years?

Well, it's certainly a market that we are paying attention to. And it's a market, you're right that we have some work in space today, whether it's on the National Security Space side or certainly the NASA side, it's been part of our DNA and what we've done for our customers for years, but it's not one that we've probably aggregate it all together and looked at as a particular market area that we should bring together under common leadership. So it's an area that we've been studying hard over the last several months. In fact, we've got a senior executive that has been chartered to take the lead as far as really refreshing our strategy in that particular area. And I think out of that process, you might see us make some moves in areas where we think we can capitalize on positions that we already have in a more meaningful way. I recognize it's a competitive area with certain -- and so we're going to be very thoughtful around those potential entry points where we want to have a bigger role. But where we've got existing programs that give us a jumping off point to do something more impactful, you'll see us in all likelihood, try to go all in on some of those moves. So again, I think there's no downside the way I look at it. National Security Space, particularly has probably got a little bit more growth upside than some of our other market areas. And if we're able to do anything more in that particular area, it creates upside opportunity for Leidos relative to the expectations that we recently set.

Okay. Well, we're getting very close to the end of our allotted time. And I, again, don't know why we had the technical difficulties we did to get started, but we very much appreciate your participation in our conference. It's been a long, good partnership with Leidos and Credit Suisse. And I don't know if there's some final thoughts you want to convey to the audience, please feel free.

Well, Craig. First of all, it's all great to see you, and I do appreciate the long-term partnership that we've had with Credit Suisse. Again, I think Leidos, hopefully, the viewers out there that didn't know the story, got a taste of why would we think we're different and compelling in this particular area, were excited about the portfolio of products and services that we put together and the markets that we're in, under the leadership that we have. So those of you that are interested, I encourage you to reach out to our Investor Relations team to learn more. But thanks again for having me today, Craig and look forward to catching up if you can soon.

Likewise, and have a great holiday. Thank you very much, Chris.

Appreciate it.