Leidos Holdings, Inc. (LDOS) Earnings Call Transcript
February 8, 2022
Earnings Call Speaker Segments
Thank you very much, and welcome to our session with Leidos. We're delighted to have with us Roger Krone. Roger is their -- the Chairman and CEO. And so we're going to talk about Leidos and about the industry writ large.
I know one of the questions that's certainly on my mind, I assume on a lot of investors' mind, is that like 2 of your peers, Booz and CACI, just reported weaker sales than expected. And their December quarter is quite a bit weaker, and they basically had talked -- come out with their projections in like late October. So they kind of missed by a fair amount when they were 1/3 of the way down the river. And so they mentioned a lot of issues, mostly related to COVID, the impact on customers. So Roger, give us your take on the environment, like really what's happening, how is it impacting customers' behavior?
Yes. Well, Cai, thanks for hosting us today, and it's great to be back, albeit virtually. I can't wait, of course, it's probably the second or third year I've said this, I can't wait to be back in person. I'll just do the preamble, is we're a week away from our year-end earnings call. So some of the detail I'm going to give is still going to be a little circumspect because of where we are in the process. But hey, I think I can address your comment and probably cover most of the subjects that you want to talk about today. Yes, I think the challenges that our customers put forward are real. I think they fall in line with the comments that we made on our third quarter call. And here we are in February, and we're looking at another deadline on the 18th of February for the expiration of the next continuing resolution. And so you take COVID, Omicron, you take the CPR, you take what appears to be the priorities of the administration, which seem to focus on Build Back Better and infrastructure and other things, and it creates some headwinds. And procurements have slowed. We have seen that, so things have gotten delayed. Everyone is dealing not so much with the pandemic, but I think it's the on-again, off-again, here, we thought we were done with Delta, and now, we've got Omicron. And I think if our employees just knew they're going to be at home for 6 months, that would be fine. But we have phases in how we open our facilities. And we have been fully closed 25% to 50%, to fully open back to 50%. We were back at 25% occupancy, and now, we've gone back to 50% occupancy because we're seeing the back side of Omicron.
What impact has -- because in talking to some folks, they've been complaining about the Pentagon, the Pentagon basically having occupancy limits. And some folks have said, "Well, they've had the occupancy limits before, but they didn't really enforce them." But now, after Biden wanted the mandate, everybody has to get vaccinated, that didn't go through. They basically are sort of dealing with the issue by all of these, as you made the point, the on-again, off-again, but more recently, just off-again until Omicron is behind us. Is that something you're seeing at the Pentagon that your customers kind of are disrupted by all of that?
Yes, I think that's a fair assessment. Yes, I'll talk a little bit more about what's been happening, is we had gotten to the point, say, in the summer where I was having meetings again in the Pentagon, and so you had to be vaccinated, you had to show a card. But I think Delta and now Omicron, the Pentagon has really reassessed their status, and they've essentially locked the building down again. I was recently on a rather well-publicized meeting with the Secretary of Defense on hypersonic technology. And that meeting, in my estimation, might have been better to have in a classified facility, but because of Omicron, we all did it virtually. And I think that is weighing on what I would call the acquisition officials, the program managers, the people who have to get the work done to get the acquisition process running smoothly and efficiently. And so we've continued, I think, to see programs move to the right, to acquisition delays and things like that. But I'm not being critical at all of the Pentagon. I think we need to take Omicron very, very seriously. We've lost 22 employees in total to COVID. We've lost 3 employees just since the 1st of the year. And although we don't know for sure that they're Omicron, I think it's safe to say that they probably did die of Omicron. And so there's this Executive Order 14042, which would mandate vaccinations or exemptions for all employees. And Cai, as you said, it's been held up in the courts. But trying to get everyone vaccinated or have a medical or a religious exemption, I think, is a positive thing to do. I think the Pentagon is setting the example. We're up in the low 90s in verifying and validating our employee base. And we're all just trying to keep everybody safe. But as a result, I think some of the process has slowed down.
Got it. And what direct impact is COVID having on your operations in terms of hiring others, able to hire folks, keeping folks in the labor utilization? Is that a big impact?
Yes, it's clearly a mixed bag. We are fortunate, we went to a virtual hiring platform in March of 2020, and we have continued to be, I think, reasonably successful in attracting and hiring new employees. And we're in the 10,000 or so a year of the number of employees that we hire. We don't net that because we have attrition. During COVID, our attrition went way down from historical levels. I think we all benefited from that. I think if you were working at your house, the idea of a changing job probably wasn't very attractive. Now in 2021 and 2022, we see those numbers coming back. People have sort of, I think, mentally embraced the pandemic. And if they were interested in going to a different company or leaving the industry or retiring, they're doing that. I think we are seeing some of what probably the Pentagon and others are seeing, the Great Resignation. I think for those people who might be retirement-eligible, that Omicron may be the straw that broke the camel's back. And they said, "Okay, I've been through 3 or 4 waves of this. And I have enough to retire on, and I'm going to move." I think it makes our job more challenging. I think we have to be more creative. But I'll also tell you, I think the team at Leidos has done a really, really good job. We have put together the virtual hiring platform. We do new employee orientation virtually. We have people who are working from home, who have never been into our office. I would say it's not ideal. But as we move forward into the new normal, Cai, we're going to go to sort of a more mobile, more flexible workforce. And we've changed our HR policies. We have people that they don't want to work exclusively from home, but they certainly want to work from home on Mondays and Fridays. And if you live in the National Capital Region, you would know why. The traffic here is horrible. But they still want to be connected. They want to be connected to a great company like Leidos. So we are -- we have a program called Leidos Life that we are rolling out, that among other things, kind of encourages managers to not have meetings on Fridays. So it lends itself to a work-at-home Friday, flexibility in the hours that you come in, so you can time shift, and doing other things to really embrace the new normal. But I think the Omicron did create some inefficiencies. And as I said before, I think it's the, oh, my gosh, I thought we were done again, and then Omicron hit, and the numbers spiked very, very quickly. By the way, Cai, as you've seen in the newspapers, our numbers are falling off equally as fast as they came on board. But no longer am I saying that I think this is the last wave. I think we're just -- mentally have gotten adjusted to that we're going from pandemic to endemic, and that this is something that's going to be with us for a long time.
Exactly. So I think you've indicated the Afghan withdrawal should pare about 1% from -- pared about 1% from your revenue last year. Is that also going to be a headwind in 2022? And then the bigger question, are there offsets that, yes, you are out of Afghanistan, but now, people are putting much more focus on China, so that basically, at some point here, gets washed out?
Let's see, the answer, probably yes. It's not exactly one-for-one, and by the way, the skill set probably isn't a complete transfer. But we had talked about $80 million in last year, and I remember that was a partial year. So if we look at the headwind from that, you might double it to say, in 2022, you're talking more like $160 million of Afghan revenue that we would have to make up just to stay even. I'll make this statement. This is one of the big unknowns. I don't know what's going to happen in Eastern Europe. I don't think that there is an opportunity in Eastern Europe for an Afghan-like deployment for us. And what I've always said is the threat of conflict is often better for industry than the actual conflict. But we know we're deploying troops. There's probably a heightened level of activity somewhere in Eastern Europe. And that might give us a small amount of revenue. But our job is going to find it in other programs, things like hypersonics, Joint Command and Control, some of the emerging programs that are better tied to this thing that we call great power competition. And we've energized our team to assume that Afghanistan, that revenue never comes back and that we have to go find ways to make it up.
Got it. So one of the things you've talked about is scale and basically the ability to chase larger programs. You've been particularly successful in takeaways and consolidation bids. So the biggest one near term is Enclave. I assume everybody and his brother has been asking you about it. But how do you rate your chances and why? And when should we see a decision on that one?
Yes. So the program that you're talking about is the DISA, Defense Information Services Agency, a program we refer to as Defense Enclave Services. And of course, we're acronyms, so from here on out, we'll call it DES. So...
DES. Okay.
We'll talk about it on our call in a week. We'll talk about DES.
Okay.
So we're in the final throes. There are 2 competitors left, at least that's what our belief is, us and GDIT. It is a very large program. It may be the largest program that we have ever pursued. I would go back and check my numbers, but certainly at that level. We have submitted what's called our final price revision or our best and final offer, we call it FPPRs now, final price provision. We did that a couple of weeks ago. I assume that the customer is in their process, made their decision going through peer review and briefing up through their chain of command. We would like to think the award will happen before the end of the month. But like everything in COVID, that could be -- you might add a week or 2 to that. And I think we could see something, maybe early in March. It's a very, very important program to our customer. It's going to help to motorize the backbone for the department. And I'm sure that the competitor has been really aggressive in putting together a great technical offering. We think we have as well. I'm a 50-50. I think I would do a better job of picking who's going to win the Super Bowl than DES. And by the way, I asked my team these same questions. I rode up in the elevator with our proposal manager. I asked him the same questions. And we're all optimistic, but we're nervous, and because there are 2 competitors, the way we run our numbers, it's a 50-50 chance. But it would be a great program. It complements some of the work we already do up at the agency under our GSM-O program, and we would be ready to execute. It will have a ramp-up similar to what we did on our Navy NextGen program, where we were very successful in staffing that, frankly, ahead of the ramp-up. But I think we're pretty confident in a Q1 announcement. And then, Cai, just because of the size and the scale and the importance of the program, it's our expectation that there will be a protest and probably a GAO protest, so add 100 days. And then after that, I mean, I...
Court of Federal Claims?
Court of Federal -- could be in Court of Federal Claims. Of course, I think everyone in the audience knows Court of Federal Claims does not have a set time frame. And so that could be 100 days, it could be 120 days. So we're not thinking about DES in our business plan until late summer.
Got it. So when you -- this is such a huge contract, and both of you basically have DISA already as a customer. Does -- will DES take -- if you lose DES, does it take away business you would otherwise have had or that you have today?
Yes, a little bit, not as much as some of the other programs that we chase.
Got it.
It's a lot of new business. It's a lot of scope and expansion. We have a little bit of historic -- I think GDIT has some of the historic, but it is a new program, it is not a recompete.
Okay.
There are probably some other partners with DISA who will lose business when this program awarded. But it's not a huge take, if you will, takeaway per se, like again some programs that we've talked about in the past.
Got it. And so one thing, you did lose -- I believe you lost a $4.5 billion NGA IDIQ to GDIT. You guys had shared the contract for a while. Where are you? You're protesting the thing. What does it mean if you lose the protest?
Yes. This is a -- there were 2 programs, and this is sort of a combination of our user-facing services program that we had and a program that GD had, and they're sort of combined and moved forward. So for us, that will be a loss, the USF work will stop, and it's in the order of $100 million, plus or minus. We don't like to protest. We're not a serial protester. Often, we will file a protest where, in the debrief, we find it difficult to exactly understand why we lost. And without going into specifics, we really want to learn more about the evaluation process and why, in a couple of certain areas, we were scored the way that we did. And after getting the debrief, we wanted to learn more. We did ask more questions, and these were very scripted-type events. And so we did end up filing a protest with the GAO, and we -- there was a stay of the work, which means both ourselves and GD are continuing in the legacy contracts. And that process has started, and the time clock has started as well.
Got it. So if you take DES to the side, what's your pipeline of large bids look like? Anything in particular that are sizable that we should be on the lookout, i.e., in the enterprise IT space or your product-related areas?
Well, yes, of course, a lot. We're really active in the space. Our pipeline, all the things that have been qualifying at any given time is almost $200 billion. We stand today at about $35 billion in proposals submitted and not awarded, and that includes some major protest activity. Maybe I'll touch on those first. The NISC program was just reawarded to us, I think, earlier this week or late last week. So that's a positive. There's a program called AEGIS, that if you follow us, you know that we won, and then it was protested. That protest period expires, I think, on Thursday. So we ought to hear from that. We have another program called [ FILMS ], which is in corrective action. And we would like to think that's a couple of weeks away from being decided. And then there's just a whole slew of other programs. FENS is an FAA network program. We had hoped it would be a first quarter award. The customer has sort of informed us, based upon the volume of submittals and the complexity of the program, it looks like that will probably slip until third quarter. We like -- we would like to see it a little earlier. But -- and then after that, there's a whole host of smaller programs. There's an Air Force as a Service program where we're teamed. There are a handful of things up in the intel area. There is a recompete of the program management office for the electronic health care records program for the Veterans Administration that we are contemplating bidding, based upon the work that we've done on DHMSM. But it's -- we're not at a loss of things to bid on and to go chase. And then a little bit of the first question, Cai, we've had a significant number of opportunities, even RFPs and draft RFPs, move from '21 to '22. So if we can get an appropriations bill and get new programs started, we think we could see a little bit of heightened activity in the second half of '22, which will lead to awards in '23 and '24.
Got it. Okay. That's very helpful. And so how should we think about your recompete rate in '22? I mean roughly, what percent of revenues that you now have are kind of up for recompete?
Yes. '22 is actually a little bit more favorable for us on recompete. Most of the recompetes are sort of behind us. Normally, we have thrown out a number, like 20% in any given year of our programs get recompeted. We're going to be a little bit below that in '22, maybe more in the 15% range. Some of the very, very big programs, like our Hanford mission essentials and other programs like GSM-O, those have already been recompeted, and we have won those. So a little bit less than we traditionally have, which is good for us. I think it speaks to the strength in our backlog and where we start the year.
Got it. So I know, basically, Hanford and GSM-O, you basically retained that. You have had a very good net takeaway rate. As you look at your competitors, are there any of them that you're kind of worried, like these guys are starting to improve their game from where they were a couple of years ago, so you're -- that's a bigger relative concern than it's been?
Listen, I think a couple of years ago, I was as equally concerned about our competitors as I am today. This is -- I'm often asked in my prior job at one of the big aerospace primes, what's the biggest change in this industry? So this is a hypercompetitive industry. We compete all the time. I don't come to work and -- in any given day and not touch a proposal in some way. We are writing proposals, we are competing, we are doing this all-in every day, and so is everybody else in the industry. And what we are seeing as a trend, from a Leidos standpoint, is we have encouraged our team to bid on more to, if you will, expand the aperture. Some of the M&A that we've done have gotten us into some new markets. So we're probably bidding on a broader set of opportunities than we would have, say, 3 to 5 years ago. And that means we're more expeditionary in some of our proposals, which means our loss rate is going to go down, right, because we don't have the incumbency, we don't have the relationships. And often, when you're trying to create a relationship with a new organization, you kind of have to lose one before you win, understand their process. And so we would expect probably our win rate as a percentage to go down, but our dollar numbers to go up, if that makes sense because we're going to bid on a broader set of work. But that being said, I'm still really proud of the job that we've done here from a business development standpoint, the quality of our team, the quality of our offerings. But this is kind of like baseball. You're not going to win every one. And if you're anywhere near, your baseball kind of batting average is you're doing really well.
Got it. So at Investor Day, you talked about a '22 to '24 growth goal of 5% to 6% per year. Is this likely to be linear? Or could it be front-loaded, back-loaded? Or any comment you could make that you think -- how do you think about that?
Yes. I think given we're a week away from a fourth quarter...
Okay.
And probably a '22 guide, I think I'll maybe just talk a little bit about the market because...
Okay. That's good. That's good.
At Investor Day, we talked about the market growing about 4.5% all-in for us. And I don't see a lot that's going to affect that one way or the other. And the value, we think, of our portfolio approach at Leidos is when one market is up, one market is down. And so if we see the administration change priorities to more civil infrastructure and Build Back Better and health care, we think that top line number is still good. And then we saw -- and we showed this at Investor Day, probably a little lower growth number in the defense and intel space, maybe at the 3%. We saw health probably leading the pack, up in the 5 or the low 5s, and with civil and Dynetics in the middle and with the idea that, at the federal, the overall federal budget level, that's pretty predictable. And then what the administration does is they change priorities within that. And if they change priorities further, we think we're in a good position to take advantage of that. Again, the wildcard is something like a larger presence in Eastern Europe as a result of an invasion, let's say, the Ukraine by the Russians, and strengthening of NATO. And again, that could be what we thought we would never do again, the Overseas Contingent Operations funds that are added to a base budget, which would be maybe some upside in the defense and intel world. But it's way too early to understand how world events are going to play out in Eastern Europe.
So one of the issues that's come up is kind of China. We had -- I'm trying to think of his name, yes, Matt Pottinger was interviewed by my colleague, Roman. And he was making the point about Xi basically has sort of said, "We're going to take Taiwan at some point and all these people who sort of make nice." But really, that's what he said. You don't know when it's going to happen. And everybody talks about the shift to China. Have you seen a really big shift in terms of the administration kind of mobilizing sort of efforts regarding China that have impacted your business or that you expect to impact your business going forward?
Yes. I mean that's a really complicated question for someone like a contractor to answer. We're certainly seeing a huge emphasis in hypersonics, both from a hypersonic weapon standpoint, think about it as offense and defense against hypersonic weapons. And without saying much, but I mean, there have been articles that I have read about a demonstrated capability. Again, I've just read those articles. And there are things that go along with that, the Joint All-Domain Command and Control, things that allow us to leverage the equipment that we've always got and to operate in a more efficient way. The whole concept, and whether we call it strategic defense or great power competition, certainly, the discussions and the briefings are there to say that it has rolled into a series of new programs that we can tag as, okay, that's a result of a renewed threat. Maybe a little premature, but as I was saying before, we did have this industry consortium get together on the hypersonics. I'm going to assume that's associated with an emerging threat. And by the way, that's both offense and defense. You got to be able to play on both sides. But I believe we had hoped as a country that we could get away from counterinsurgency. And it's not clear that we can ever completely let go of counterinsurgency and do a complete shift. I think I read again in the newspaper about a special operations, where it just continued to remind us that it is still a very complex and complicated world. And we will shift maybe the center point, but we're still going to have counterinsurgency. We really have to take the great power competition seriously. And I suspect we're going to be doing both for a long time.
Got it. So one of the things that's happening is your debt ratio is easing. How should we think about your cash deployment priorities going forward? Like when would you do some, or might you consider something bigger? Or just speak to me about how do you think about those priorities?
Yes, well, Cai, it's one of the most consistent positions that we've taken as a company since I've been here, and our priorities are still the same. First of all, I'll just remind everybody, at the Investor Day, we talked about cash flow generation equal to about 100% of adjusted EBITDA. And I think we'll continue to do that. There's no change in our basic business model that would cause us to be different. And in the absence of other alternatives, we continue to expect to generate a lot of free cash. But again, our priorities are what they have been, and what we say every quarter on our call, we're investing in the company for program execution and organic growth, so capital, have better systems, better IT. We bought some assets at times to fuel growth. We want to make sure we're making the right investments in the business that we have. We're a dividend payer. That, in some aspects, makes us unique in our industry. We have actually raised our dividend a couple of times recently, and we're going to continue to do that. We are selectively in the M&A market. And I think you've observed that we have become even more selective as of late, smaller deals, more focused, really targeted towards capabilities that we want to add to our portfolio or market access or both. We have not done the big deals at scale. Really, I think Dynetics was probably the last deal that we did that we would call a significant deal. And so that leaves us in a position with, we think, a fair amount of cash that we can't use in the business. And we're always excited to give that back to our shareholders. And we love the dialogue with our owners about what is the most efficient way for us to get that money back to them. And we expect, in 2022, to continue in that way. And we expect that we will have excess cash and we'll give that back to our owners.
Got it. And so -- but you've done deals and you've done deals in the product area. What impact do you see from the FTC's 4-to-0 vote against Lockheed's proposed acquisition of AJRD? Does that have any impact in terms of your sector or the way you think about M&A?
Well, I think it certainly signals a different sense of priorities from the FTC in the Hart-Scott-Rodino process and by the way, an aggressiveness, and maybe that we haven't seen in a while, to actually go to vote. And this has -- I don't know the exact details of what Lockheed did, but I'm sure that they put a proposal forward of how they would mitigate the OCI and to make this pro-competitive rather than anticompetitive. And it would appear that, that didn't satisfy the FTC. I think it is a message that says vertical integration may not be viewed well by the FTC. And it would cause, I think, all of us to scratch our head and say, well, what do they think about industry consolidation, that they may have a view there. It's not really going to change our strategy because, as I said earlier, we sort of moved away from that. We are looking for very unique technologies that improve the differentiation in our offerings. So we bought a small company in the third quarter that machines carbon material to create thermal protection systems, a very small deal, but very, very highly skilled, unique. And that helped to fill out the work that we do, and the common hypersonic glide body is part of the hypersonic weapons program. That's a perfect deal for us, and it's small. It didn't affect our leverage. It's very, very focused. These are really highly skilled people. It was a unique capability, and we're pleased to do it. And that's what we're looking at. While we're also looking at non-M&A, equity investments, debt investments, we announced a small investment into a new space company called HawkEye 360, really to help establish a relationship with their company and get access to their data stream and understand what they're producing and to have a strategic relationship.
Do you feel you have enough scale at this point?
Yes. We certainly feel we have scale. We're essentially the industry leader in our segment, is I don't see a market where we need to double-down for scale, right? And we were fortunate enough to make a major move back in 2016. We've added to that in a couple of key areas. And we're very, very happy with our size and scale in our portfolio. We still are very excited about growth. We think there are markets that our market share is very low, and we want to grow in some of the markets that are a little bit nontraditional for us. And we've got initiatives within the company where we're trying to do that organically. But I just don't see a scale play for Leidos. And going back to your question about the FTC, it is not clear to me what the FTC in this new regime feels about scale either.
Got it. And last question, since we're coming down to the hour, as you think about 2022, what are the things, what are the key risks, what are the key opportunities you see for Leidos?
Yes. The risks are things that we've already covered. We want to get to an appropriations bill. I think the risk is a continuing CR. There's some risk of a government shutdown. I mean it's not 0, but we don't think that's fairly realistic. We're worried about the next wave of COVID, things that we don't understand and what that new normal looks like. And then all the implications of we will have to hire another 10,000 people or so because we have attrition, and we want to net a certain number and so being able to access talent at the salaries that we have bid. So there is a bit of an inflation question, and we could go off on inflation for some time. But I think if we can get inflation back in check, we're okay for the short term. On the opportunities, we have been very successful in winning new programs. We're amazingly pleased with the opportunities in front of us. And all of those programs either got to scale in 2021 or will get to scale in '22. So Navy NextGen will get a full year of that at full scale. The Military Family Life and Counseling, we will have a full year of that at scale. We'll be ramping up the Reserve Health Readiness Program, albeit not as quickly as we had once hoped, but by the end of the year, we'll be fully staffed there. We're hopeful that AEGIS will get through the protest period. And by the end of the year, we'll be at full scale on the AEGIS program. And then a program you always ask about, our defense health program, we're now doing double waves, and we started doing double waves last year. And 2022 will be the first year that we're doing double waves all the way throughout the year. So just executing on the programs that we have in backlog will help to drive our growth in 2022 and fuel the future of the corporation.
Terrific. Well, I think we are right about at the hour. Thank you very much. Really appreciate you taking the time to join us, and a great session. Thank you.
Great. Thanks. Thanks, Cai. Have a great rest of the day.
Same to you.
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