Leidos Holdings, Inc.

Greetings. Welcome to LIDO's third quarter 2024 earnings call. At this time, all participants are on a listen-only mode. A brief question and answer session will follow the form of presentation. Please note, this conference is being recorded. At this time, I'll turn the call over to Stuart Davis from Investor Relations. Stuart, you may begin.

Thank you, and good morning, everyone. I'd like to welcome you to our third quarter fiscal year 2024 earnings conference call. Joining me today are Tom Bell, our CEO, and Chris Cage, our Chief Financial Officer. Today's call is being webcast on the investor relations portion of our website, where you will also find the earnings release and supplemental financial presentation slides that we'll use during today's call. Turning to slide two of the presentation, Today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, includes 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, as shown on slide three, during the call, we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is included in today's press release and presentation slides. With that, I'll turn the call over to Tom Bell. We'll begin on slide four. Thank you, Stuart, and good morning, everyone. As always, it's great to be with you all again today. This morning, I'm very happy to report our sixth straight quarter of excellent financial performance. And I'm also very proud of the fact that the team has delivered high quality wins and crossed the entire Leidos portfolio. As a result of this strong sustained financial performance, our growing business capture momentum, and our increased clarity into important Leidos markets, we are again raising our forward guidance for 2024 across all metrics. Chris will provide full details regarding our outstanding financial performance and our improved 2024 guidance later on this call. This quarter's solid organic growth and industry-leading margins enabled us to deliver substantial earnings growth and free cash flow. With record adjusted EBITDA margin of 14.2%, we've now achieved 12.9% EBITDA over the trailing 12 months. This excellent execution performance is the result of our robust portfolio of programs serving customer priority missions, our investments to drive efficiency, and the team's embrace of a promises-made, promises-kept philosophy throughout our capability-based organization. Our performance in this quarter reflects adjusted diluted EPS growth of 44% and free cash flow conversion of 159%. Our outstanding cash collections this quarter also enabled us to accelerate share repurchases. We purchased $200 million worth of shares on the open market, thereby clearing $450 million of our $500 million planned share repurchases for the year. As a result of our sustained performance and our conviction regarding our portfolio's ongoing earnings cap and cash profile, we have again increased our quarterly dividend. Shareholders of record on December 16th will receive a dividend of 40 cents a share, a 5.3% increase over our past dividend. The balance sheet strengthening we've undertaken over the past 18 months gives us excellent optionality. And this will be important as we begin to focus more capital in the future on our new North Star growth strategy. But for the remainder of this year, uses of capital will continue to be prudently focused on the potential for additional share repurchases and purposeful down payments on specific growth engines that have come into focus as a part of our new North Star strategy. We look forward to sharing more detail about our new North Star strategy and its suite of compelling Leidos growth engines at our upcoming Investors Day in March. Starting today, I'll take the opportunity from time to time to highlight one of our compelling Leidos growth engines. Today, I'll start this practice with an overview and update on our health and civil segment. Over the past year, our health and civil segment has been a growth and margin leader for us. Our team in health and civil is executing extremely well. And within this newly formed segment, They are optimizing performance across their broad portfolio, and in doing so, they are leveraging the synergies of the complete set of scientific experts we employ, what we refer to as our ologists, who come to Leidos to break limits in their careers and deliver superior results for our customers. We're seeing strong performance and positive developments across the full array of health and civils customers, including our work for NASA, the National Institutes of Health, the various customers of our air traffic management systems, and our virtual health solutions customers. One area of this segment that I know many of you track is managed health services, where we bring truly differentiated solutions to our customers, which in turn unlock truly differentiated performance. Currently, a core offering within our managed health services is disability and occupational health evaluations for a wide range of customers, including the Department of Labor, the FBI, and the US Secret Service. Included in these flagship programs, we perform medical disability examinations for veterans and active duty members preparing to discharge. Exam volumes for this business have remained elevated based on the permanent increase in the eligible population from the promise to address Comprehensive Toxins Act, better known as the PACT Act, signed into law in August of 2022. Because of our continued ahead-of-the-curve investments in this business with AI, virtual health, and other key technology enablers, and investing in overall capacity, we're positioned to continue to respond with quality and speed to the increased volumes and complexity of exams the PACT Act creates. As an example, we've continued to expand our fleet of mobile clinics to meet the needs of underserved veteran populations. These include those living in rural communities, tribe members on Indian reservations, and homebound veterans. And to assist our veterans beyond our own Leidos QTC clinics, We've developed cutting-edge care coordination processes and algorithms for the VA. These help the VA optimize their use of their critical imaging systems, such as CT scan machines, to ensure veterans are receiving quality and timely healthcare across the whole of the care ecosystem. I'm exceptionally proud of our performance for the VA and for our nation's veterans. We are focused on working with the VA to continue to drive down case backlog and deliver timely, exceptional service to veterans and service members. On our last earnings call, I relayed that volume and profitability of this business might be challenged in the second half of this year. I expressed this caution at that time because of the real customer budget challenges and the lack of clarity regarding an upcoming re-compete for some of our work. Consistent with our promises made, promises kept philosophy, we issued improved guidance then that was prudent given the uncertainty at that time. I'm happy to report that we now have much greater clarity on both these fronts. First, Congress approved a $3 billion supplemental funding request by the VA for the government fiscal year 2024. And this was passed with clear bipartisan support. So we fully expect Congress to approve the VA's $12 billion request for fiscal year 2025. And second, the VBA has already exercised the option year contained in our current region's contract. In addition, we've submitted what we believe to be a compelling bid for a new two-year contract for this same work. And we expect to receive a contract award for this important work in the coming weeks. We very much look forward to continuing our longstanding partnership with the VA in service to our nation's veterans. With this current option year in hand and the new two-year contract ahead, we are very confident in the ongoing financial performance of this business. We expect the volume and margins of our future work here to be sustained on the back of the investments we've made and continue to make in throughput and quality. And looking beyond this new two-year award, we remain confident in our ability to continue to differentially serve our nation and its veterans. The VBA is encouraging offerors to drive even more innovation into veteran services before they award the next set of long-term contracts. And this plays to our strengths. With our scale and technical depth, our investments in cutting-edge trusted mission AI, and the talent and mission focus of our team, we are poised to demonstrate our ability to handle even greater volumes of exams with excellent quality, timeliness, and bettering customer satisfaction. Turning now to business development, as you know, we've been focused on fundamentally resetting our future performance expectations by improving the size and quality of our backlog. This third quarter yielded an excellent return on this focus with net bookings of 8.1 billion, representing a book-to-bill ratio of over 1.9 times. We ended the quarter with a total backlog of $40.6 billion, including $9.1 billion of funded backlog. And importantly, I'm very pleased with the improved quality of this future work. Quality wins this quarter were balanced across all our segments with a rich mix of new growth drivers. Here is a sampling. We won over 700 million in new and takeaway wins in full spectrum cyber. This is a testament to our capability and competitiveness in this market. It's also an early success from the investments we've made in repeatable solutions in our digital modernizations sector. A couple key awards to mention this quarter include developing the Army's new general unified network to deliver a next-gen transport capability compliant with Zero Trust principles. And we won a large classified takeaway contract for a member of our intelligence community. The Air Force tapped Leidos as its digital integrator to oversee planning, analysis, and operations of its Advanced Battle Management System Digital Infrastructure Network, a core component of the Air Force Battle Network. This comprehensive network links together all Air Force assets, allows for optimal coordination between different units, and enables commanders to respond rapidly to the changing situations on the battlefield. The $300 million award augments our growing portfolio of combined joint all-domain command and control programs. And we had $1.7 billion of net bookings within our defense system segments. Reflecting our maturing product portfolio there, on IFPC Enduring Shield, we received an award for additional development work and four more launchers after government-led development tests successfully intercepted a mix of unmanned and cruise missile targets. This means we remain on track to receive a low-rate production contract in 2025 and a full-rate production contract in 2026. We finalized our contract to provide wide field of view Tranche 2 satellite payloads. This means we will continue to serve our nation with payloads on the SDA's Tranche 0, 1, and 2 satellites. We received a contract from the U.S. Special Operations Command to restart production of our small glide munitions program. This program blossomed a decade ago from a Cooperative Research and Development Agreement, or CRADA, and we've now delivered more than 4,000 units. Of note, we're also on CRADA for a next-generation small cruise missile system called Black Arrow. Recently, Black Arrow completed multiple tests at customer ranges and will undertake even more advanced flight tests this fall. We believe that Black Arrow will help meet the DOD's critical need for affordable standoff strike systems that can be quickly produced and fielded in volume. It's encouraging to see these and other significant results from our focus on growth across our entire portfolio. The third quarter was also marked by high volumes of proposal submissions. So looking forward, even with the large number of Q3 awards, our pipeline of bids awaiting adjudication grew by $3 billion and now stands at $29 billion at the end of the quarter. We believe this positions us very well for even greater business capture performance in the future. As referenced earlier in our conversation, because of the hard work that the team has put into our year of deep strategic thinking, our new North Star strategy has come into clear focus. From the kaleidoscope of opportunities in front of us, I can confidently say that the rigorous process we have undertaken has unveiled an exciting set of focused opportunities for us to accelerate Leidos growth, top line, bottom line, and cash over the coming years. That path forward and the compelling financial picture it will spawn will be the focus of our March 2025 Investors Day. I'll now turn the call over to Chris to walk through our financial results in detail and provide additional insight into our improved outlook.

Chris? Thanks, Tom, and thanks to everyone for joining us today. Our third quarter results again showcase what is possible as we lower performance risk, focus on high-quality wins, and drive efficiency through the organization. This team is laser-focused on sustainably growing earnings in cash and deploying them responsibly to grow shareholder value. Turning to the income statement on slide five, revenues for the third quarter were $4.19 billion, up 7% year-over-year. Customer demand remains robust, and employee retention remains historically high. margin performance was once again a standout in the quarter. Adjusted EBITDA of $596 million was up 32% year-over-year, and adjusted EBITDA margin increased 270 basis points to 14.2%, a new high watermark for Leidos. Program-level execution was one catalyst for margin performance. EAC adjustments were a $30 million net positive, our best performance in nearly four years. Non-GAAP net income was $396 million, and non-GAAP diluted EPS was $2.93, up 40% and 44% respectively. On a year-over-year basis, our slightly higher tax rate in the quarter fully offset our slightly lower diluted share count and net interest expense. Looking at the non-GAAP reconciliation tables in the press release, in presentation appendix, You'll see $6 million of gap impairment charges from exiting and consolidating underutilized lease spaces. And we expect another $15 million or so of charges associated with additional actions over the next five quarters. We're closely managing our corporate costs and lowering our real estate footprint improves our competitiveness and keeps corporate costs in check. The annualized savings from these actions will be in the neighborhood of $25 to $30 million. which we'll see the full benefit of in 2026. Turning to the segment view on slide six, national security and digital revenues increased 1% year over year. We saw volumes grow broadly across our digital modernization portfolio, which offset slowness across several intelligence community programs. I'm very pleased with the margin discipline of the segment as they continue to perform ahead of plan. National security and digital non-GAAP operating income margin increased 70 basis points from the prior year quarter to 10.5%. This was their highest margin of the year, and it reflects early success in digital modernization repeatability and utilization initiatives, as well as excellent award fees on our intelligence community programs. As Tom alluded to earlier, health and civil continue to deliver for customers and shareholders. Revenues increased 16% over the prior year quarter, and non-GAAP operating income margin came in at 24.2%, up from 16.5% a year ago. Revenue and margin over performance was primarily in the managed health services portfolio that Tom spotlighted. As we received more disability exam requests than anticipated, and our differentiated solutions were able to unlock higher performance and incentives. Profitability was roughly in line with Q2 levels. Commercial and international revenues increased 5%, with increased deliveries of security products and energy engineering services. Non-GAAP operating margins were 8.8%, their highest level this year. The UK business was a positive top and bottom line contributor in the quarter, and I'm pleased with the positive trajectory for this business area and the segment overall. Finally, defense systems revenues increased 13% over the prior year quarter, and non-GAAP operating margins increased 280 basis points year-over-year to 10.2%. It's rewarding to see the kind of financial performance that we expected from this portfolio. There were many bright spots in the segment, highlighted by the move to the initial operating test and evaluation stage on FPIC and during SHIELD. Looking across the segments, Clearly, health and civil continued its strong execution, but I'm most encouraged by the broad-based strength of the entire portfolio. We had two sectors growing at double digits for the first time in the new organization structure, and if you set health and civil aside, margins for the remaining three segments were up 80 basis points from a year ago and higher than they've been as far back as we have recast financials. Turning now to cash flow and the balance sheet on slide seven. With the end of the government fiscal year, we had exceptional cash performance. We generated $656 million of cash flows from operating activities and $633 million of free cash flow. In Q3, we repurchased a total of $203 million in shares, including $200 million in the open market, and paid $51 million in dividends. We ended the quarter with $1.2 billion in cash and cash equivalents and $4.7 billion of debt. we have significant capacity to return cash to shareholders and invest in growth. Next, I'll go through our enhanced outlook for 2024 on slide 8. We're raising and narrowing our revenue guidance range to $16.35 to $16.45 billion, an increase of $150 million at the midpoint. We're increasing adjusted EBITDA guidance from approximately 12%, to the high 12% range. We're raising and narrowing our non-GAAP diluted EPS guidance range to $9.80 to $10, which is an increase of $1.10 at the midpoint. And lastly, we're increasing our guidance for operating cash flow by $50 million to approximately $1.35 billion for the year. Our new guidance reflects not just the outperformance in the third quarter, but also an improved outlook for the fourth quarter, spurred by positive momentum across all four segments and increasing visibility in our health and civil segments through the re-compete of the region's contracts. As you put together your models, we're expecting fourth quarter interest expense, tax rate, and diluted share count to remain near Q3 levels. We plan to step up CapEx investments tied to growth in Q4 and end the year at $160 million, or about $30 million below our original expectations for the year. Finally, as Tom indicated, our year of deep strategic thinking has brought our North Star strategy into clearer focus. We're not yet ready to give next year's guidance for new long-term targets, but I want to orient you to our current thinking. Our very strong performance in 2024 raises the bar for next year. The midpoint of our revised guidance range yields revenue growth of 6% and diluted EPS growth of 36% in 2024. At this point, we're not expecting to repeat quite that same level of growth in 2025. We see 2025 as the pivot year from the company we are to the company we're building towards as we implement our strategy. We currently expect revenue growth in 2025 to be in the lower single digits. with the longer-term growth outlook potentially back to 2024 levels or above. Most importantly, we are committed to retaining margins near current levels and robustly and sustainably growing diluted EPS over time. With that, operator, we're ready to take questions.