Greetings. Welcome to the Leidos First Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Peter Berl of Investor Relations. Peter, you may begin.

Thank you, Rob, and good morning, everyone. I’d like to welcome you to our first quarter 2021 earnings conference call. Joining me today are Roger Krone, 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 2, 2021. Roger will lead off the call with notable highlights from the quarter, as well as comments on the market environment and our Company's 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 is included in the press release that we issued this morning and is also available in the presentation slides. The press release and presentation, as well as a 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 Krone.

Thank you Peter, and thank you all, for joining us this morning for our first quarter 2021 earnings conference call. As we communicated in our press release this morning, I'm pleased to announce that Chris Cage will be Leidos' next chief financial officer later this year. Chris will succeed Jim Reagan who has chosen to retire following a long and distinguished career, in particular, the last six years as my good friend and business partner. I will have a few remarks on this transition before I hand the call over to Jim, but first let's jump into the quarter. First quarter results reflect the perseverance, focus, and tremendous execution of our employees and business partners. New quarterly record levels of revenue, non-GAAP EPS and backlog were achieved, and significant organic growth was delivered across all business segments. This early momentum favorably positions Leidos to deliver on our full-year financial commitments. Revenues for the quarter were $3.3 billion, up 14.7% from the prior year, and up 9% organically, underscoring our accelerated recovery from last year's pandemic headwinds and the early ramp of new business wins. Adjusted EBITDA margin of 11.7%, up 240 basis points compared to the prior year period reflects strong program performance and the resolution of the long-standing MSA legal matter, which together delivered 45% growth on non-GAAP EPS of $1.73 for the quarter. Net bookings of $3.8 billion resulted in a book-to-bill of 1.2 times and 1.3 times on a trailing 12-month basis. This increase, driven by success in both our Solutions and Health segments established a record backlog of $32.6 billion for a 13th consecutive quarter, providing greater clarity and confidence in near-term revenue growth expectations. I will now touch on a few of the major wins we received in the quarter that underpin our growth and…

Thank you, Roger for those kind words and thanks to everyone for joining us on the call today. Upon reflection, I've had a very fulfilling career and these past six years here at Leidos have been truly special on account of all of the passionate and brilliant people who work here. I deeply value the relationships that we've built and the accomplishments that we have achieved together. I have great confidence in Chris's ability to lead the finance organization and I look forward to working with him on a seamless transition. With that, I'll start by providing an overview of our first quarter 2021 results, followed by an update to the 2021 guidance. We are pleased with our strong start and growth momentum through the first quarter of 2021. First quarter revenue grew 14.7% over the prior year quarter and 8.9% organically. The increase in revenue was driven by the Dynetics SD&A and 1901 Group acquisitions, growing on our existing -- growth on our existing programs and increased contribution from new programs. This solid start to the year aligns with our fourth quarter messaging and showcases our resilient program execution fundamentals with all segments delivering double-digit top line growth. Adjusted EBITDA margins of 11.7% grew 240 basis points over the prior year quarter. The increase was driven by program performance, mix and continued indirect cost management, as well as the benefit from the successful settlement of the MSA legal matter. Excluding the positive impact of this $26 million legal reserve adjustment, adjusted EBITDA margins would have been approximately 11%. First quarter non-GAAP diluted EPS of $1.73 grew $0.54 over the prior year quarter, driven by strong execution, and organic growth, as well as the settlement of the MSA legal matter. Without the settlement, non-GAAP diluted EPS would have been $1.59…

[Operator instructions] Thank you. And our first question comes from the line of Sheila Kahyaoglu with Jefferies. Please proceed with your question.

Thank you very much. Good morning, Roger and Jim congratulations on your retirement.

Good morning, Sheila.

Good morning. Maybe just because you spent a few minutes on your prepared remarks talking about this Roger, and obviously there's an acquisition this morning from one of your competitors, can you talk about your Health Division? How do you expect revenue growth to kind of work through within some 30% implemented at the moment or deployed? And just bigger picture in terms of the Health market, how do you see it evolving, whether the growth or just competitive nature of it?

Well, let's see, on DHMSM we will be at our current revenue level or higher for another couple years. And Sheila, as you know, our Health Group has traditionally been our highest margin and our highest growth area and it's not surprising to us that others have seen the market as attractive as we have. And the interesting thing about the Health market is, it's always been highly competitive, and whether it's one of our competitors getting into one of our traditional businesses, it's just changing the name of the competitor. And it is a very much a commercial world and now we see the Biden Administration, maybe the Human Infrastructure Bill as it comes to pass, is continuing to increase the spend. And we think it raises the importance of agencies like CMS and Social Security. And that's going to attract maybe some new competitors and maybe some non-traditional competitors which in our strategic view of the market, we have always expected. And we believe we are successful in that market because we offer value added service to our customers and we are if you will sharpening our tools and getting ready for what we think will be a significant growth in the top line in the market overall.

Thank you.

Our next question is coming from the line of Robert Spingarn with Credit Suisse. Please proceed with your question.

Hi good morning, and congrats Jim, best wishes ahead.

Thanks Rob.

On the defense margins, they were sequentially up and above the level you had achieved previously in any quarter last year. So, I wanted to talk a little bit more about the drivers, you did touch on them, you talked about mix, et cetera, but and just whether COVID related margin pressure is easing there and if you can quantify the impact of the international receivable there?

Yes, just starting with the last one, think of the recovery on the international receivable is $2 million or $3 million or so. I think more fundamentally the businesses performed well on execution basis. Companies with portfolios of our size always have a program or two that are not making their planned margins, but the execution in the Defense Group has been going pretty well, including the strong management of indirect costs, which has also been something that's provided them with a lift. Now that said, we do have an R&D budget that we under spent a bit in the fourth quarter and we expect that the level of R&D spending to tick up a bit through the balance of the year. And that's important for our long-term strategic priorities that are going to grow the business at strong levels going forward. Last thing that I would say is that there's -- as we think about the margin in defense for the rest of the year, it's going to continue to be strong, but I don't think you should necessarily be thinking of the Q1 level as being something you'll see every quarter for the rest of the year.

Jim, is that the case in all the segments you touched on this earlier that the second half is just a little bit lighter because the first quarter or first half was elevated, is that all three segments?

Well, you know, in Health we've got the backlog burn down that we talked about that because of the way the operating leverage in that segment works, the margins are going to be a little higher than normal through the second quarter of the year. Those margins will damp down a bit in the backend. But unless we find that healthcare costs are lower than we expect and if we find that our ability to generate proposals is more efficient somehow than we are currently modeling, I think that you could expect the margins to be a little bit lower in the back end of the year and that is across the board, yes.

Yes. Thank you very much.

Sure.

Our next question is from the line of Cai von Rumohr with Cowen. Please proceed with your question.

Thank you very much. So, could you comment a little bit on the burn off of the backlog of the medical exams in the Health area and what that means going forward? And then somewhat relatedly, Roger, you talk of the 16% increase in FY '22 Fed Civil budget. Talk about the opportunities you see there? Thanks so much.

Yes, let me start with the backlog. So, just for everyone on the line, we do medical exams for those people who are looking for disability benefits. Our largest customer is the VA, but we do them across the board. And during COVID there was a period of time we were shut down and a period time that our efficiency was diminished because of social distancing, and so there was a inventory or backlog of people who want these exams. And it grew up pretty much through last year to really for us, an all time high. Our commitment has been to work literally nights and weekends to over staff our clinics to work off the backlog. And we're benefiting in this quarter by that although we did have some weather in Texas and other states that damped our quarter down just a little bit. But we think it will take us into the third quarter before we get back to our normal run rate. That's our best estimate today Cai and we look at that level. The team looks at it every day. I look at it. Jim and I look at it on a weekly basis. We look at it by region and by type of exam. But we're making good progress. The backlog is significant and we think it's probably going to affect third quarter as well. And this is all positive by way as it was severely negative a year ago and we talked through that a year ago. As we think about the increase in the budget and about all we know at this point Cai, is what agencies look like they're getting the increase and we are all waiting for the PB to come out. But it does look like these are agencies for which we have a significant presence and significant heritage contract. So, it's civil infrastructure, it's also some health. I mentioned in my prepared remarks there's going to be ports and borders and airports, FAA infrastructure, those seem to be prime. There's probably going to be some roads and bridges, which is not really all that relevant to us. We think there may be some smart cities, smart highways, and we do have some contracts with the Department of Transportation, so we may benefit there. But the details are yet to be revealed and when we are on the call next quarter we will have the budget and we will be able to address those better then, but thanks for your question Cai.

Thank you.

Our next question is from the line of Gavin Parsons with Goldman Sachs. Please proceed with your question.

Hey, good morning.

Good morning.

Good morning, Gavin.

Congrats to both Jim and Chris.

Thank you.

I wanted to follow up just a bit on Cai's question there. That 16% initial request number, often that gets revised, but it does seem like there is more appetite in DC for raising non-defense budgets, may be there had been for the last two years. So, I just -- what are your thoughts on kind of weather that growth rate in the mid-teens or even double-digits is actually realistic and what the request messages for the multiyear defense budget outlook?

Yes, Gavin it's really hard to handicap the most watched sport in the national capital region which is our political process. Yes, I think they're going to go to conference. I don't think they're going to try reconciliation, but they could. And if central mansion [ph] from West Virginia, who has some influence, I think they'll come down a little bit and defense may go up. There are some politicians that we talked to who say it's, assume it's sequester and it's a tit for tat. So, if you're going to take Civil up, you have to take Defense up. I don't think that's exactly where we're going to land. I think we're probably going to have higher growth number on Civil than Defense. And by the way the Defense number, depending upon where you call it, 704, 715 or 753, does include the pay raise and now all go [ph] in the base budget. So if you look at it from that standpoint, the overall you could say has some downward pressure. The areas that we compete we view as just generally flat. We are though, I think when the dust settles and we get through this year and we get a bill, are expecting maybe high single or low double-digit increase on the Civil side. And that's going to benefit our Health and our Civil Group. We've already, as you would expect, put teams together to try to anticipate where those funds are going to be spent and to make sure that we're doing the prep work to get ready to provide customers value on programs that they're going to come forward with. We actually think cybersecurity is a good area for us. We think DHS is what's called the CISA which is their cybersecurity office which tends to deal with cybersecurity in the dotcom space. We expect them both to get money in the base bill and money in the infrastructure bill. So, cybersecurity overall looks like a good place to be. Thanks Gavin.

Our next question is from the line of Tobey Sommer with Truist Securities. Please proceed with your question.

Thank you. Over the last handful of years or so customers have been a little bit more willing to contract using different methods that end up being more profitable for service providers. What's your expectation for sort of a flattening of the defense budgets, meaning for the ability of that trend to continue in yield, good profit margins for the space?

Yes. Tobey let me see if I can address your comment and then I will let Jim add is, we tend to perform better when the contract is either fixed price or time and materials, where frankly the risk of performance is on us and then we can invest in, you know we can put in RPAs or something to drive more efficiency in the contract. We have something we call our cost based contract. You know, we are kind of limited on the earnings potential based upon the fee that we bid on the contract. And with fixed price we again -- we are almost immediately rewarded for technology innovation on the contract. It's always hard to call trends and I'm not sure we've seen, because not all of the officials have even been confirmed on the Biden Administration. I wouldn't say that we have seen a trend away from T&M. When you started, I thought you are going to talk about OTAs and I would simply say OTAs are alive and well and I don't see that changing. And maybe this is wishful thinking. Yes, I would like to see the customers go to more fixed price because I think it's fixed their cost, so they don't have to worry about year-over-year plus outs and it gives us performance responsibility and then the ability to earn more over the life of the program if we can drive efficiencies into the contract. I don’t know, Jim, anything you want to add?

Yes, just to pile on that, that also delivers a benefit for the customer because when we have more latitude in how to deliver a solution as opposed to something that's prescribed in a cost type contract, it allows us to help the customer save some money too.

And if you could just provide a little bit more commentary and color on the relative size of the opportunities within the infrastructure space, I think in your prepared remarks you mentioned airports as well as research? Thanks.

Yes, let's see, I think it's too premature to give you a number. But for instance when I said research, we are safer, healthier, and more efficient through IT, engineering, and science. And a lot of people have forgotten about our science work. And so, we run the National Cancer Lab for NCI as part of HHS. We also run the National Energy Lab up in Pittsburgh for the Department of Energy and that's another great program where -- and we do essentially early stage 62 [ph] kind of R&D and we expect certainly the Energy Lab in Pittsburgh where in the last administration we did a lot of work around coal and how we can burn coal cleaner and more efficient. We would expect this administration will spend a lot of money on renewable. And we see the charter and the work in the National Energy Technology Lab really growing as we think about wind and solar and hydro, and so that will grow. And then there are a lot of other places, we do work on the Defense Threat Reduction Agency and really across the board we do some work for the Army up in Fort Detrick, in the medical field. And so, we don’t talk a lot about it because there's not a big contract like Navy NextGen in our science work. But our heritage of doing early stage scientific work is alive and well and of course as everyone knows we were founded as the science application company. And so we still have a fair amount of business in that early stage work.

I appreciate that. Thank you.

Yes.

Thanks Tobey.

Next question is coming from the line of Joseph DeNardi with Stifel. Please proceed with your question.

Oh thanks. Good morning.

Hi good morning.

Good morning. Roger, just on the SDA business, I think the expectation when you all bought it was that, it would be about $500 million of sales and grow at 10%, it looks like you're running about $300 million now. Where do you expect that run rate to be by the end of this year? And then what are you all looking for on the infrastructure side to kind of give you clarity on what incremental opportunity that could provide for that business?

Let's see, we obviously don't guide by below -- we don’t guide by segment much less by program and so we're not going to do that now. We have said that the SDA business overall has been impacted by COVID and there is less airport traffic and so that's affected the business. And more so overseas, where funding is tied to the ticket surcharges. So, we are going to be below our business case when we bought the L3 business for this year. That being said, in the U.S., we continue to see strong activity by TSA and Customs and Border patrol in buying equipment, because in the U.S. the purchasing dollars are really not tied to volume, they're tied to the Federal budget. And as I said in my prepared remarks, we got an award on VACIS. We had gotten an award on rail at the border. We are bidding on upgrading, adding something called CT at the check point at major airports. We actually have a prototype in demo at Dallas. If you come and visit us you will likely, well if you leave from here you will go through our CT at the checkpoint scanner at Dallas Airport. And we would expect some of the infrastructure dollars out of the Stimulus Bill to be spent on ports and borders, maybe some on airport and we're already working at those opportunities. I'll also tell you that really country by country, you know some countries are down. There are other country opportunities that have popped up that were not in our plan. So, it's always a mixed bag, but if you were to walk away from the call, I want everyone to know that the pandemic still has affected the SD&A business and where we might have expected we'd be fully recovered at the end of this year or into next year. We think it's probably the end of '22, beginning of '23 before we're back to normal volume.

That's helpful. And then Jim, a lot of focus on cash flow obviously last quarter. I'm wondering if you could just provide some perspective on the updated guidance for this year of $875 million, is that a level of operating cash that you can grow off of in 2022? If not, what are some of the headwinds you face there? Thank you.

Yes, absolutely. The change in the guide is really as I said in the prepared remarks, the result of the expected cash coming in from the MSA settlement. We clearly believe that we should be moving back toward a conversion rate of about 100%. The headwinds for this year really are the reversal of all the tailwinds we had last year. And going forward into '22 the only real change in conversion would be because of significant growth that will require the funding of working capital for receivables and you know, think of that as being roughly, the net amount of that, net of payables is about 27 days of sales is kind of the net working capital metric that we model based on.

Okay it would be that working capital plus the payroll tax, those would be the two primary headwinds in '22?

Yes, that is right.

Okay, thank you very much.

Sure.

Our next question is from the line of Seth Seifman with JPMorgan. Please proceed with your question.

Thanks very much and good morning and congratulations Jim. I just wanted to ask about the Civil segment and so, if we back out the legal settlement there, the profitability was a little bit lower than what we're used to seeing, and sort of what drove that and you expected to kind of move back into that sort of low double-digit range in Q2 that we saw last year?

Yes, historically the Civil segment has had a little bit more volatility in its operating income margin number, primarily as a result of the timing of delivery of product out of the security products business and this year will be no exception to that. We have some orders that are in the pipe that are being built, probably you will see those ship in the second half of the year and you can probably see volatility on the other end for that, that's what our forecast is telling us.

Okay, I will just stick to one. Thank very much.

All right. Thank you, Seth.

Our next question is coming from the line of Mariana Perez Mora with Bank of America. Please proceed with your questions.

Good morning everyone and congratulations to Jim and Chris.

Thank you very much.

Good morning, Mariana.

So, my question is on SD&A. Yesterday [indiscernible] announced they expect awards from the TSA to expand the deployment of checked baggage screening equipment to all federally managed airports nationwide. Can you please describe what was light or small on that contract and also like discuss competitive dynamics on that business?

Yes, Mariana, it is a great question. The contracts that you are bringing up, we did not bid on it. That is a -- that's a contract to support the maintenance of the checked baggage screening machines. And we chose to really pursue a path of bidding on the larger contract, which is checkpoint equipment of all kinds, whether it's the screening machines or scanners or trace detection equipment. And we were concerned that to try to bid both of them could compromise our ability to get the bigger prize which is the one we're pursuing and you should hear about it sometime this month.

And how is competitive dynamics there for the main competitors and how has that over the last year?

Well, we currently hold what I think is the largest contract for the maintenance of the checkpoint screening equipment and while the TSA has divided that up, we have consistently gotten good performance ratings and we think that we're well positioned to win a big piece of that work later this month.

Thank you.

Thank you. Our final question is coming from the line of David Strauss with Barclays. Please proceed with your questions.

Thanks, good morning. I wanted to if you could provide an update on dynamics. It looks like the revenue run rate there just based on disclosure around the acquired revenue was a little bit lower, is that just seasonality? And then anything you can say with regard to the lunar-lander and the protest there? Thanks.

Well see, I'll start off and let Jim kind of catch you up on numbers. First of all on the Dynetics integration the team is going really well. You know there growth on a standalone basis is really eye watering. And we've integrated our Leidos Innovation Center into Dynetics to better cross fertilize our technology with their technology and that has really created a lot of excitement and we will see dividends of that in quarters to come. But performance at Dynetics is really solid and they continue to win programs in their relevant area and our hypersonic glide body facility is up and running. I was down there two weeks ago, three weeks ago, it's going classified. We actually have parts that we're building and really across the board Dynetics is going well. I will give you a little bit of insight on HLS. I can't give you much. So there were three bidders two of which everybody in the country knows and us, and the contract was given to SpaceX and upon our debrief and our review we felt that things needed a closer look, and so we did file a protest, and I'm not going to disclose a lot of what's in our protest. There is some stuff out on the web. There was a good article written out of the Washington Post that I would refer you to and I would also caution that the Washington Post is owned by one of the companies that was a competitor, but I still thought that the article was very thoughtful and is a good basis of trying to understand what's going on in the HLS program. And because our protest is really sort of and it's not quite a lawsuit, but it is certainly a dispute with a customer, I'd just rather not comment at length on our protest, but they typically last about 99 days and so in a couple months we will see what comes out of the HLS program.

Yes, and in terms of the numbers, it is our policy that we don't include pro forma pre-acquisition revenues in calculating our growth rate. And so we didn't include strong growth that Dynetics had on a standalone basis last year in our growth numbers. Now that it's -- we had it for a year. We are including it and we do expect that as it is a part of the Defense Solutions segment, we expect that to show some continued growth into 2022 and 2023.

Hey Jim, I think the question may be around, you know we break it out in page 14 of our calculation in the back, but after 12 months we break it off and so what you're seeing, $83 million number, yes, the 83, that's a sub period. So you don’t, you should not think of that as being the Q1 revenue from Dynetics and so I think Dave, what you might be seeing is just a partial period there and it might be misleading here to think that the revenue is down in Dynetics when in fact Dynetics is still continuing to performance well.

Yes maybe to close at the end of January a year ago, so that's…

Early February.

Yes.

Yes, I was just comparing $83 million for one month versus kind of what you're -- had been your $300 million quarterly run rate the last couple of quarters.

Yes, I think that's just a little, it's just a timing thing, yes for sure.

All right, thanks very much.

Yes, okay thanks.

Thank you.

Thank you. At this time, I will turn the floor back to Peter Berl for closing remarks.

Great, thank you Rob, and thank you all for your time his morning and for your interest in Leidos. We look forward to updating you again soon. Have a great day.

Thank you. This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.