Leidos Holdings, Inc.

Greetings. Welcome to Lido's first quarter of 2020 earnings call. At this time, all participants will be in listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. At this time, I'll turn the conference over to Peter Burrell with Investor Relations. Mr. Burrell, you may begin.

Thank you, Rob, and good morning, everyone. I'd like to welcome you to our first quarter of 2020 Earnings Conference Call. Joining me today are Roger Crone, our Chairman and CEO, Jim Reagan, our Chief Financial Officer, and other members of the Leidos Management Team. Today, we will discuss our results for the quarter ending April 3, 2020. Roger will lead off the call with notable highlights from the quarter, as well as comments on the market environment and our company strategy. Jim will follow with a discussion of our financial performance and our guidance expectations. After these remarks from Roger and Jim, we'll open the call for your questions. Today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. Finally, during the call, we will discuss GAAP and non-GAAP financial measures. A reconciliation between the two was included in the press release that we issued this morning. It is also available in the presentation slides. The press release and presentation, as well as supplementary financial information file, are provided on the investor relations section of our website at ir.leidos.com. With that, I'll turn the call over to Roger Crum.

Thank you all for joining us this morning for our first quarter 2020 earnings conference call. These are challenging times for all of us, and I sincerely hope that each of you and your families are both safe and healthy. First quarter results demonstrate the resiliency of our business as evidenced by strong pro forma organic revenue growth across all business segments, significant bookings, and a new record backlog position. While the COVID-19 pandemic presented some late quarter headwinds, we are confident that the critical nature of our work, coupled with our early business contingency planning, will mitigate any long-term impacts. In the quarter, the business delivered revenue of $2.89 billion, reflecting 12.1% growth from the prior year. Adjusting for acquisitions and divestiture activity, the pro forma organic growth rate was 8.2%, demonstrating the continued conversion of our successful business development campaigns to revenue. We delivered non-GAAP diluted earnings per share of $1.19, up 5.3% from the prior year. We generated $372 million of cash from operations and ended the quarter with a strong cash balance, of $445 million. Net bookings of $5.5 billion yielded a book-to-bill of $1.9 for the quarter, a significant achievement compared to our historical pattern. With several recent favorable protest resolutions on single award IDIQs, we expect additional bookings as incremental task orders are awarded against these vehicles later in the year. Adjusted EBITDA margin of 9.3% was lower than prior year. Primary factors were late quarter COVID-19 headwinds and a charge related to an international receivable. The impact of COVID-19 in the first quarter was approximately $50 million in revenue and $9 million in non-GAAP operating income. As discussed during the first quarter earnings call, we closed the Dynetics acquisition back on January 31st. The integration activities are progressing as planned. On a pro forma basis, Dynetics delivered approximately 30% top-line growth in the quarter demonstrating that business's strength in fast-growing strategic areas such as hypersonics, space exploration, and unmanned systems. Just last week, Dynetics was awarded one of three prime contracts by NASA under the Artemis program to develop a human landing system through the preliminary design phase. Our contract consists of two phases. a 10-month base period for preliminary design valued north of $250 million, followed by a down select to two contractors for a four-year option period to build and send a lander to the moon. This win will be captured in our second quarter bookings and backlog. Following the theme of M&A activity, yesterday we announced the closing of the acquisition program of L3Harris' security detection and automation businesses. We are excited about what this acquisition means for our future in the high-growth, ever-expanding global security market. While COVID-19 is causing a temporary impact on airlines and airport traffic volumes, The lower traffic scenarios are actually causing many airports to consider pulling in upgrades and maintenance activity during this unseasonably slow traffic period. After careful review of first quarter results and the business's pipeline, including recent discussions with key customers and prospects, We remain confident that this transaction will create significant value for Leidos, our customers and our shareholders. We welcome the 1,200 employees to the Leidos family and look forward to updating you on our integration and synergy activities over time. We continue to expect this acquisition to be accretive to revenue growth, adjusted EBITDA margins and earnings this year. Jim will provide more details on this later in his remarks. As of today, reflecting both acquisitions, our estimated net leverage ratio is 3.7. As we have stated consistently in the past, our target net leverage ratio is 3.0, and as such, Our capital deployment philosophy will prioritize debt reduction until we approach that level while sustaining our quarterly dividend and funding important capital and R&D investments to continue to drive growth. From an organic growth perspective, I'd like to highlight a couple of notable programs from the quarter that reflect the successful defense of two protests in our defense solutions segment and one in our civil segment. In all three cases, Leidos is the incumbent. The first is the Global Solutions Management Operations, or GSMO, II contract. where we continue to manage a series of networks and computer systems that serve as the backbone of the Department of Defense's command and control systems. This 10-year, single-award IDIQ contract has a ceiling value of $6.5 billion if all options are exercised. Note that the GSM02 contract has yet to contribute materially to our backlog and will do so over time as new task orders are issued. Second, the protest of the Department of Energy's Hanford Mission Essentials Services contract was also resolved in our favor. The 10-year single award IDIQ contract has an approximate value of $4 billion if all options are exercised. Finally, the Air Force National Capital Region, or AFNCR, Information Technology Service Support Contract was also successfully defended. Under this five-year, $450 million single award IDIQ contract, we will continue to provide a full range of support and services to our nation's command and control systems and IT support for thousands of users. During the COVID-19 crisis, we are enabling teleworking capabilities through hardware, software, and cloud-based service deployments. To support our business's continuing growth, our talent acquisition efforts continue to attract and hire 100 or more new employees each week. We hired over 1,800 in the first quarter. This result is made possible by our recruiting and onboarding programs, which adopted a number of virtual practices well before the current COVID-19 crisis. Turning now to COVID-19. This global pandemic is affecting us all. At Leidos, we have been carefully managing the impacts to our people, our community, our business partners, and our customers. We have implemented changes to our business rhythms to maximize telework where possible and minimize risk to our employees. We have revisited and improved certain health care benefits for our employees to minimize the burden on them and their families during the crisis. I am proud to report that the whole Leidos family, from employees up through the board, have stepped up to offer aid in their communities through generous donations. Since the start of the outbreak, employees have donated nearly $400,000 to the Leidos Relief Foundation to assist their colleagues who have been directly impacted by the virus. Last week, our board of directors unanimously approved a reduction in director compensation for the current year. As a result of this decision, the company will contribute half a million dollars to the Relief Foundation. Additionally, I have donated my salary to the Relief Foundation during the pandemic. Externally, the company has contributed more than $250,000 with a commitment to match up to an additional million dollars of employee donations to the All of Us Combat Coronavirus campaign created by the U.S. Centers for Disease Control and Prevention Foundation. Our customers recognize the critical nature of the services that we perform, and the overwhelming majority of our work remains without impact. We have identified approximately 270 million of revenue, or about 2% of our total for 2020, that is expected to be impacted by COVID-19, much of which we expect to recover in 2021. The passage of the CARES Act does provide some relief for us and our industry peers. However, since the specific implementation is left to the discretion of contracting officers, we are not allowed to bill fee on certain contracts where the workforce is kept at home in a ready state. This is the cause for the majority of margin reduction in the defense solutions segment. To minimize business impacts and to continue to deliver innovative solutions in a cost-efficient manner, we have implemented a number of cost-cutting measures across the organization. These actions include reduced discretionary spending, an indirect hiring freeze of nonessential open positions, and mandatory time off on alternating Fridays for indirect staff. In a few minor areas where we have seen reduced business volumes, furloughs have been implemented. Beyond this, it is worth highlighting that Leidos supports many customers who are in the news today for their efforts on addressing the pandemic, including NIH, CDC, FDA, and others. We are unique among our peers in the breadth of our health capabilities and have been engaged with all of these customers and more to leverage our capabilities to directly help combat the pandemic. First, on behalf of the NIH's National Cancer Institute, our subsidiary, Leidos Biomedical Research, staffs and operates the Frederick National Laboratory for Cancer Research, which is dedicated exclusively to the biomedical sciences. Frederick National Laboratory scientists have been working directly with the NIH to facilitate an international therapeutic trial of remdesivir in COVID-19 patients. Second, the Frederick National Laboratory scientists are also conducting research to identify genetic determinants of virus susceptibility and outcomes, hopefully leading to better therapeutics and medicines to combat the virus. In other parts of our health business, we have been exploring opportunities to develop and offer virtual care solutions which support the complete pandemic pathway, from patient intake and prescreening to virtual visits with staff physicians via remote monitoring within the hospital or other care environments. While these are challenging times for all of us, the mission-essential nature of our work The additional protective measures in the CARES Act and the significant actions we are taking as a company provide a strong foundation for our business as we manage headwinds entering the second quarter. Jim will give more detail on our revised guidance, but in short, after reflecting... both the expected COVID-19 impacts as well as offsets from the inclusion of the L3 Harris security acquisition, our revised guidance enables us to maintain our cash flow from operations guidance at the same level as before, at a billion dollars or higher, while decreasing revenue by 1% and earnings per share by 6% at the midpoint of our range. From a macro perspective, fiscal year 21's budget levels for both defense and non-defense spending are set under the bipartisan budget agreement, and Congress does not plan to change those levels despite the unprecedented spending increases being enacted to offset the economic impact of COVID-19. Consequently, there should be more certainty in the budget process this year even though we expect fiscal year 21 to start under a continuing resolution due to the November elections. Longer term, however, deficit pressures could impact both defense and domestic spending levels, potentially starting as early as fiscal year 23. But again, the 18 to 24-month delay from budget dollars to outlay dollars does still provide us with runway before we are potentially faced with that dynamic. Further, DOD's unobligated balance of over $100 billion could mitigate the impact of any future cuts to budget authority in the first one to two years of a downturn scenario. Finally, in closing, I'd like to comment briefly on the transition in our investor relations team. Peter Burrell was recently appointed as head of our IR team and brings over 25 years of experience across numerous financial departments within Lockheed Martin and Leidos, where he most recently served as CFO of our health group. Peter succeeds Kelly Hernandez, who, after six years as our IR lead, was recently named the new CFO of our civil group. I'd like to thank Kelly for her many contributions in her prior role and know she will be a great asset to the civil group. With that, I'll turn the call over to Jim Reagan, our Chief Financial Officer, for more details on our first quarter results and our full-year outlook.