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

All right. Good afternoon, everybody. I'm Noah Poponak. I'm the aerospace and defense analyst here at Goldman Sachs. Very happy to have with us for our next presentation, Leidos. And with us from the company is Chris Cage, the CFO. Chris, thanks so much for being with us.

Noah, it's great to be here. Thanks for having us out. I always enjoy your conference, great venue. Good day at meetings. So yes, happy to cover anything you want to cover.

Awesome. I think most people in the room and most people listening probably know who you are and what you do, but maybe just for those that don't and just to kind of kick us off, maybe just a quick overview on who is Leidos? What do you do? Where do you sit in the end markets?

Sure. So Leidos, we closed last year at almost $14.4 billion in revenues, a government technology services company in a variety diversified portfolio focused on 3 main areas: our Defense Solutions business, which includes both services and some certain defense products. We have a civilian agency business that supports a number of important customers like the FAA, TSA, Department of Energy, et cetera. And then we have a very exciting health business that's also predominantly focused on support to defense and civilian agency customers in the VA and CDC, CMS, et cetera. So diversified, like I mentioned. We've been on a growth trajectory and looking to continue that momentum as we move forward with both growing the top line and the bottom line. And so the other exciting news is we just underwent a CEO transition. So our new CEO, Tom Bell, just joined us last week, and we're very excited to embark under his leadership.

Maybe spend another minute on that. We spent a lot of time with Roger. We have somebody new at the helm here. I mean, from your perspective, will it sort of be business as usual or anything you guys are talking about doing a little bit differently?

Well, I don't want to speak for Tom. He's been on the job for, I think, today's his 5th official day, but he's been coming up to speed quickly on the company. I mean, first of all, Roger Krone had an exceptional run. I mean, almost 9 years as CEO and the company grew from approximately $5 billion in sales when he first joined to, like I said, $14.4 billion on its way to $15 billion this year. So an excellent run. He added a lot of capabilities over the years through acquisitions and grew and expanded the markets that we're in. Now Tom comes on board and Tom has had great success, both at Boeing and most recently at Rolls-Royce and elsewhere. He's a proven leader. I think Tom will come in and get the best out of the team and he'll focus pretty immediately on the strategy and making sure we're executing appropriately on the '23 plan and building the '24 plan, and prioritizing how we allocate capital to make sure we're focused on delivering sustainable, profitable growth for the company. So I think everybody has welcomed Tom. He did a great town hall and the employee population are very excited to work under his leadership.

Awesome. Okay. There are a lot of headlines out there about what the U.S. is going to do with total spending. I guess, where do you shake out on what your end market budget growth rates are going to look like in the final government fiscal '24 and then also more in the medium term?

Yes. So politics around the debt ceiling and the budget dynamics have been quite challenging, certainly. But our view, of course, is we'll come through that and nobody in Congress wants to see the U.S. -- to put the [ U.S. ] credit rating at risk. But in the near term, we've anticipated it's going to be challenging in the fall. I mean, a continuing resolution is par for the course. So that is kind of the standard operating procedure for the U.S. government. How long that lasts into '24 is really the open-ended question. And a prolongated continuing resolution could be impactful, right, to the markets at large, and the ability to continue to deal with challenges that are happening globally, certainly a ground war in Europe and the increasing China threat. So we like our portfolio in the sense that through ordinary times and reasonable budget environments, we're in the areas that are a focus for our customers. But in the near term, again, I think the activity level has been good so far this year. Customers are awarding contracts. We're seeing new opportunities to bid and submit, and I believe that pace of activity will continue, but we're prepared for a scenario where in the fall, we have to operate in that CR and then the real question is what impact does that have as we transition into the '24? TBD, but we're preparing for new scenarios.

Okay. Do you think the final 2024 DoD budget will be higher or lower than the request?

I think we've been talking about that throughout the day. I mean I'd say I'm in the camp of we'll see some upside there. But it's -- again, we got a long journey to get through to make that a reality. I think if you step back and look at the threat environment, if you look at inflationary environment, there is support, but of course, politically, there's a lot of wrangling to be done. And so how does that ultimately get resolved? How does that get paid for? What's going to happen on the tax front to potentially raise revenues to offset that? We'll see. But I think that something that continues the momentum in the key program areas would be beneficial for the nation. And we're hopeful that we can come out of this with a path forward that allows us to continue to grow the top line to support critical missions.

Okay. And then there's also been the dynamic of the outlays trailing the authorization for a while there, that gap was pretty wide. It seemed like it was closing, then it kind of opened back up again. And it seems like that was contracting officers either leaving the workforce or going remote and just all of the pandemic-related disruption. How close to normal, is that at this point for you?

Well, I mean, again, there definitely has been some disruptions in that decision-making cycle. We've certainly seen certain agencies where the shortage in contracting staff was more impactful. I'm encouraged that we saw a little bit of improvement in our intelligence business in the first quarter. So that's good because that was one of the areas that was most impacted, I'd say, for the longest period of time. But clearly, we're not out of the woods. So I think it will be an ongoing battle. Some agencies have done a better job. We've seen the Space Development Agency now under the Space Force, for example, moved with pace and speed and been able to do things on schedule, but other agencies have struggled a little bit. So I think that's an ongoing dialogue with your customers trying to get ahead of things and position for where possible, can you expand and use existing contract vehicles versus new procurements. We're actually seeing some of that on a vehicle that we won last year called Sentinel. And so we're finding that certain customers are bringing work to that vehicle because it's already in place, and they don't have to worry about the procurement cycle. So taking advantage of IDIQ type of arrangements that are already in place is one path forward for customers to do, and we're encouraging that.

So it sounds like -- you sound relatively relaxed about where that's going from here that there's been enough sort of creativity around resolving that problem.

I don't want to sound overly optimistic. I mean, my job is to make sure that we're looking and preparing for the downside scenario too. But yes, relative to where it was last summer and taking all the way till March to get a budget in place, it has improved in my opinion and my observation relative to that. And hopefully, we'll continue to see some positive momentum in that front.

And is there going to be a window of catch-up related to that, where the companies in the industry are all kind of beating top lines because there was all this pent-up demand of dollars that weren't spent and it all gets spent? Or will that sort of just kind of spread out over time into the future?

Yes, there's a possibility. I mean there's also the potential that some of those dollars get swept up and reallocated too. So there's always risk in that if you wait too long to get appropriations and outlays, sometimes money gets pulled back. But I think there's a possibility for again, customers to spend the more robust budget that they have been out there more recently. And so again, we saw good growth in our first quarter, 5% top line growth. Saw that a little bit above that in our fourth quarter. So hopeful that we can maintain that momentum, and I think a solid customer funding environment is key to that.

Okay. Maybe just expand on that growth you've seen and what you're expecting in the medium term by each of the main business segments. Civil has been particularly strong. Is that sustainable? Defense has been a little slower, but the bookings have been better. So does that have an acceleration ahead of it? And then Health at the big 2021, so the compares are tough, but it keeps growing anyway. And so maybe just give us a little bit of a view on how you see each of the businesses evolving on the top line in the medium term?

Sure. So we don't guide by segment, but I can give you some color commentary -- I'll take Defense. So I mean Defense has got a couple of different dynamics to play. You're right. We've had some nice awards in the past. Some of them, the best days are still ahead of them. For example, the Defense Enclave Services award that we won last year. The team has been executing on the first task order under [indiscernible] vehicle. The exciting part is we finally got the second task order just very recently. So we'll start to see some uptick in activity under that. And again, the path forward over a multiyear arrangement is that should transition to a really strong growth for us, again, over time. It's a critical mission. And we also -- I mentioned the Sentinel vehicle, again, that -- we're seeing more opportunities to bring tasking there. We're seeing more bid activity there. So there's a couple awards that we previously announced that have room to grow and win. And then where else do we see growth in the future airborne ISR is a mission area that there's definitely increasing demand around. And so we like the prospects there for increased level of activity and have something we'll hopefully be talking about new bids and new wins here over the course of the next few quarters. Maritime is another area where we invested in our Gibbs & Cox acquisition on the naval architecture and engineering in '21. And that one coupled with our heritage Maritime business gives us capabilities in the undersea autonomy and surface autonomy domain, and we've won a nice program there, we see more opportunities. And we see opportunities to expand that capability internationally, especially you're talking about [ AUKUS ] with the Aussies and what can we help support for them in the maritime domain. So on the defense services side of the equation, excited about the future prospects in some key areas. And then we have the Dynetics piece of the Defense portfolio. So we've been talking about that as a growth catalyst for us in the future, '24 and '25, most notably. And there's a number of things that will help drive that. We've got our hypersonics family of programs. So there's now maybe half a dozen individual programs that we have a position on. So we're right there in the heart of the hypersonics mission in a number of ways. We have had success on the space payload contract with SDA, as I mentioned, and now we're a sub to a key prime on Tranche 1. And so we see more opportunities going forward on future tranches for the Wide Field of View payloads. And then finally, on the enduring indirect fire protection program, we're going to deliver on the prototype phase 16 units this fall and meeting all the scheduled milestones and commitments with the customer that we feel will lead to the low rate production contract, which would be a catalyst for growth next year. So there's a number of things we're excited about. Some of them have moved a little bit slower than we would have liked. But I mean, big picture, looking over the intermediate term. I think they're there. Quickly on the other 2 areas. Civil has been growth on the civilian agency digital modernization work. NASA has been a huge important customer from us -- for us, and we won an important takeaway last year, but we had some other programs with NASA, but other agencies that we're seeing good chances to bid on things in the pipeline will be a growth catalyst for us. Our commercial utility business has been -- we do a lot of variety of engineering services, energy efficiency services for utility customers. That's been a nice growing business for several years now. And then looking ahead, maybe a couple of years out, the [indiscernible] great work for the FAA air traffic control and seeing opportunities internationally around some of those same capabilities. So we're excited about those prospects looking ahead in the future. And finally, the SCS business, which I'm sure we'll come back to is still an area that we expect to be a growth catalyst in the civil area for the future. Finally, on Health. We love the health business. It's performing exceptionally well. It's been growing and delivering bottom line expansion as well. We had -- we grew margins this quarter over last. And the team has -- is well positioned in a number of contract arrangements. So the SSA contract that we won in the fall last year, so that's ramping up. That's an expansion of work we're already doing. We are seeing a lot of great bid opportunities on some VA logistics work. And so we're seeing some opportunities in the CDC space as well. And finally, the Disability examination business has been performing really well, and we're seeing more volume due to the PACT Act legislation. So the increase in referrals coming our way bodes well for continued growth in that line of business, too. So a lot of exciting things going on there.

That's a lot.

It is a lot.

It sounds opportunistic, okay. One more revenue question. So your -- the guidance for this year I believe, implies that the remaining quarters of the year are relatively flat sequentially. But if I look historically, most years, it's seasonally lighter in the first quarter -- during the fourth quarter and ramps through the year. Is there something different about this year? Or is there some conservatism in the top line and work to do on the margin?

Well, obviously, we put a lot of thought into the guidance, and we think the range is still appropriate based upon how we see things playing out as of the end of our first quarter and our call. Yes. So it does -- back to our earlier conversation around budget uncertainty in the fall. I mean, clearly, there could be some impacts there that we want to be cautious about. We have to continue to win. I mean the seasonal patterns that you talked about, there is some of that in the business with work that we already have, but there's also the need to win and execute and ramp up new programs along the way. That's always going to be par for the course. But I like the path we're on, on the revenue side. I think that we've demonstrated the improvements in the growth rate. We need to continue to focus on business development engine and continuing to win at the win rates that we've seen historically. But on the revenue side, I think there's a lot of momentum to continue that growth trajectory.

Okay. Let's dive into the margins. So in the first quarter, Civil had the disappointment concentrated into the security products business. Maybe just talk about now that you all have moved on from the earnings report and the earnings call, how you're thinking about what does it take to improve the overall segment margin? And you gave a lot of detail on the call about the issues behind security products. Curious as to the duration of each of them. How long does it take to get past each of the main issues within that specific piece.

Well, the team is executing a plan. And again, it was a disappointing first quarter on margins, no doubt about that. But we're focused on making sure the problems are addressed head on. Some of them have -- I would say, we've already been able to address and feel confident those issues are resolved. Some are going to be an ongoing work in process. For example, customer-driven delays. I think we can do a better job in how we communicate with them and share schedules and escalate issues as needed, more timely, but to a certain degree, there's only so much you can control. I think we can control our internal costs to run the business, diversifying some of our supply chain issues, which we've been able to do. We've in-sourced some of the activities on the manufacturing front. So I think those activities give us some confidence that we've got some of the fixes in place. We're looking hard at the cost structure of that business, too. And doing what's appropriate to make sure that is set up for future success at varying levels of revenue volume. But I mean, again, the long-term prospects on security detection, we think are favorable. But unfortunately, this quarter had a few different things that came to pass at the same time. And so the team is working really hard to make sure we're improving on several fronts.

The customer readiness issue is what exactly its footprint expansion at their facility where they just weren't ready to take the product.