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

At least you're providing a benefit.

Yes.

And moving on to DES contract. You cleared the protest. In the last time we spoke, you were holding your breath. So I was very happy for that. You've been very clear the incremental revenues this year are minimal and it's not really additive on the bottom line. How do we see that contract ramping over the next few years?

Yes. Sheila, really interesting. So on one hand, we celebrate what is probably the largest contract we've ever won at Leidos with a ceiling value of $11.5 billion, and we booked almost nothing into backlog. So on the charts that I get to see, there's a big upward spike, and the charts that you get to see, there's almost nothing. So we've talked about this year being double digits. And next year, we might double that, but we're not going to reach $100 million next year. And the way the program works, for those who are not familiar with it, we partner with DISA to establish something called the DoD 1 Net, which is a modern open IT architecture, and then we install that architecture. We start, frankly, with DISA headquarters as sort of our beta, and then we go to other, they call them Fourth Estate non-combat organizations within the Department of Defense. And we start with headquarters, and we do a couple of small agencies. And with every installation, we kind of make our own future. And so this year, we're doing a lot of design work. And we're fully under contract, and we're working with the customer. In fact, I met with General Skinner, who's the head of DISA about 2 weeks ago, and we talked about the program. So we will start just DISA headquarters towards the end of the year or next year. We'll probably add a couple of installs next year. And then it probably doubles again in '24, and it probably doubles again in '25. And then the ability for us to get anywhere near $11.5 billion divided by 10, it's a 10-year contract, we have to be successful every day. We have to prove to the owners of these networks, the Defense Logistics Agency, the Defense Health Agency, that we can provide them their network, frankly, faster, better and, frankly, more cyber secure. And so we make our future every time we do an install. By the way, very much like we do in the defense health program with electronic health care records. The next wave in DHMSM is kind of always dependent on how successful we were in the last wave. And we've done a great job on DHMSM. There's no reason why in 4 years, 5 years, this can't be a program literally north -- in the north end of hundreds of millions of dollars a year.

And then you've done a few acquisitions over the past few years that I think have changed Leidos' capability, whether it was Dynetics, Gibbs & Cox stands out as adding ship design capability. Can you maybe talk about the broader growth opportunities. Maybe we'll stick to Gibbs & Cox and what you're seeing on the naval side?

Sure. I'd love to talk about that. Our M&A history is pretty unique. We had the terrific opportunity to do the IS&GS deal through a reverse Morris trust, which didn't leave us to double negative. We didn't have to overly leverage to get the Lockheed deal done. So we came out of the Lockheed deal with great firepower. And then we've kind of looked at our long-term strategy and where we wanted to grow. And I don't like the word bolt-on. I don't think anyone ever wants to feel, they've been bolted on. But we look for either technology or market plays in smaller M&A. And that's what we've been doing. Dynetics is like that 1901, the L3 business in the security and inspection. And with both Dynetics and Gibbs & Cox, not only do we get great people and great technology and market presence and leadership, we got their DNA, right? Their entrepreneurial, entrepreneurial view, the customer relations, how they go to market, how they view growth in their business. And the way we have organized, both of those businesses, we have combined with existing Leidos businesses. So in maritime, we had an existing maritime business that built something called, Sea Hunter which is our autonomous platform and that we essentially have put Gibbs & Cox our maritime businesses together to cross-fertilize the discipline and program management technology we had on the maritime side with these people who love ships and ship design and love the Navy and just talk about ships all the time. And we did the same thing with Dynetics and the Leidos Innovation Center, which is where space business is and things that we've done in wide field of view. Gibbs & Cox, again, we have been so fortunate to do some very unique acquisitions. And I think it's because of the culture. Gibbs & Cox was the last remaining independent naval architecture firm in the United States. All the other ship design work in the U.S. was done by one of the existing yards. And probably not known to many people, 60% of the U.S. Navy's current surface combatants were designed by Gibbs & Cox. So we did the Arleigh Burke. We did the Freedom-class LCS. We did the old Frigate. We have a contract for the new Frigate, and we have a contract for the new Destroyer. So that book of business is really exciting, but even more exciting for us, we learned bidding in the medium-sized undersea vehicle, the unmanned vehicle -- surface vehicle. We knew a lot about autonomy, and we knew a lot about ship design, but we didn't know a lot about U.S. Navy ship design. And so what Gibbs & Cox brings to us as we combine our technology with their knowledge of how the Navy wants a ship designed and operated and should help us expand our business in the unmanned surface vehicle market, both in the U.S. and overseas. And then neither of us have done a lot in the undersea and we just won a very small contract called medium undersea autonomous vehicle and have gone to market on that. It's small. You probably won't see it in any of our press releases. But combining what we learned from Gibbs & Cox with the autonomy work that we did at Leidos helps us to address a market that we couldn't address without the acquisition.

And what's going on with Dynetics? How big was the business when you acquired it back in 2020? And what does it look like today? And just given the growth profile of some programs such as Epic?

Yes. I'll try to remember, so don't hold me to the exact numbers. I think it was about kind of nominally $800 million when we bought it, and it's about twice that now. I mean, give or take, $50 million. And it grew by winning programs, in doing virus program, the hypersonic glide body program is growing, some of the weapons programs are growing. And then we combined it with our Leidos Innovation Center, which was not as big as Dynetics, it's probably in the $400 million or $500 million business. And then we had, if you will, new organic growth on top of that. And it's been a fantastic combination. I mean it's -- if you talk to Steve Cook, who runs that business and we're doing an investor opportunity in December for those people who want to come visit. But to see them come together -- and again, it's the entrepreneurial people at Dynetics and the technology that we essentially had trapped in the Leidos Innovation Center. And what Dynetics knows how to do is to apply technology to create a program, and then transition a research program to a program of record. And what we had done really well in the Leidos Innovation Center was demonstrate technology like the Sea Hunter program, the CHIRP program, our IR payload program. But what we had failed to do is to bridge what we all refer to as the valley of death into production programs. And we're now on the verge of moving 4 or 5 of those collective programs across the valley into production. So these enduring fires program, both the high-energy laser, in fact, the Lockheed laser is literally at our facility being installed on the chassis as we're here. We will probably be shooting light in the next couple of weeks. I'd say you can probably see that when you come down in December, but it may be out in test, but there's a second platform right behind it. The enduring [ FPIC ], which is the A9L, where we're a team with Raytheon, that's actually going well. That really doesn't need to bridge. All we have to do is connect it to the IBCS and shoot some missiles, and we've got a production program. So that looks really exciting. And then the common hypersonic glide body. We're under contract to get to a certain rate. We're now starting to see long lead to increase the rate there. It is, if you will, the nation's leading hypersonic capability in the worldwide battle to have a significant capability in hypersonics, and again, something that people can see if they're able to make the trip down in December. And I couldn't be more excited. And what it really gets to be going is how well the Dynetics and the link and some of the people from Reston who've kind of all come together in Huntsville to make it all work. And something we're not quite ready to completely talk about, but we are part of SDA's Tranche 0 program, which is a tracking layer. And then we bid with a company that won the Tranche 1 as the payload. And there's not much I can say at this point, but the company that we're teamed with won contract and has signed a contract with SD&A to go do their demo on the tracking layer and we're the payload provider. And again, that's the combination of Dynetics and the link actually putting a proposal together and teaming with a great prime to grow the business.

I have a minute left. So one more question, and I'm debating profitability or cap deployment. And since you just did the Cobham deal, you have -- ASR business is about $100 million. You added to it in the quarter, deals yet to close. How are you balancing cap deployment priorities from here given the $500 million ASR as well?

Yes, that's great. Let's see. We're -- we guided about $1 billion in cash. If you add the lawsuit, it's probably $1.25 billion. Our cap deployment is about as consistent as it could be. And we actually look at the words that go into the script every quarter, and we say, we want to be a dividend player -- a payer. We don't necessarily want to be a regular dividend raiser. We're really listening to investors as what they want to do. And then after that, about half of what we have, we're going to invest in growth, and that could be R&D. It could be capital spend. We could buy some assets like airplanes. It could be M&A. And then the other half, we kind of want to give back to shareholders. And when we look at the year and where we were, where our stock price was and we said that it really looked opportune to do an ASR. The business in Australia is associated with Cobham, and Cobham was bought by PE and is being sold in pieces. We're very familiar with the airborne ISR business in Australia. They fly the same brand make aircraft that we fly around the world. So we have a, as you said, $100 million ISR business that flies Dash 8s and Challengers. And so we always thought we were the logical owner of the business, but we never though that we would actually be able to get to where we want to be on pricing terms. So we made a commitment to the ASR, early buyback. I think the market responded really well to the ASR. And then we just assumed that we would pay down the debt and finish the year. And then it just -- sometimes in M&A, you can't predict when opportunities present themselves. We view Australia as a terrific market because of great power competition, what's going on in South China Sea and things. Australia is going to be very strategically important to the world, to the U.S. as a partnership, the [ OCSE ] program. And so the ability to expand our presence in Australia in a different product line in something that we know well so integration risk is minimal. And Paul Chase, who runs our Australian operation, was a P3 Air Force person. And so he understands airborne ISR, so that was a doubling down. But we'll -- by the way, we have completely hedged the deal as of the date of signing, and we actually benefited from a little bit of the foreign currency move. We don't know when it will close. So Sheila, I mean if it closes quickly, then I suspect there would be no chance that we would be back in the market. If like some M&A, it gets significantly delayed, we're not going to accumulate cash. There's a potential that we could be back in the market earlier than we planned. But I guess the high percentage is it closed reasonably quick, end of third quarter, sometime in fourth quarter. And then as such, we want to delever. And we'll want to delever down to 3 before we're back in the market. And we've been pretty clear, we expect to be in the market on a regular basis as part of our capital deployment. And I got a question earlier today, a 1% excise tax probably doesn't change our mind. We are not hyperscaler. We're in for billions of dollars in buyback. Our ASR, 1% would have cost us, what, $5 million on the $500 million. And it's money we wish we didn't have to spend, but I would rather pay the 1% than see the corporate rate go up. So I guess it's your choice of evils, 1% excise on buybacks' probably better than what we could have seen, because at one time, we were thinking the corporate might go to 28. And so keeping the corporate rate where it is, it works for us. But we're committed to give back our great cash flow to our owners and our shareholders, and buyback has been and will be a significant part of that deployment strategy.

Great. Thank you so much, Roger, for being.

Sheila, thanks. Thanks for your conference.