Leidos [LDOS] can better leverage prior acquisitions, some of which have not fulfilled their original business case, the company’s financial performance at times has been subpar and it needs more “quality wins” to grow its backlog, which will be the leading indicator of future sales gains, Tom Bell, Leidos’ new CEO, said on Tuesday.
In addition to outlining several areas of focus for improvement, Bell also said Leidos is in the process of a “strategic sharpening,” which will result in a “new North Star…to guide all our strategic decisions” aimed at boosting win rates, margins, and meeting customers’ needs.
Bell took the helm at Leidos on May 3, succeeding long-time Chairman and CEO Roger Krone, who led the company since 2014. Bell previously was president of Defense for Britain’s Rolls-Royce plc and chairman and CEO of the company’s U.S.-based Rolls-Royce North America, Inc.
As part of the North Star effort, Leidos will tune and “simplify our organizational structure to promote operational excellence, allow for faster decision-making, and more tightly align our businesses across our key technology differentiators,” Bell said during the company’s second quarter earnings call. There will also be “greater cost discipline” and an investment strategy attuned to the opportunities with the best value to the company with the aim being on the bottom-line, he said.
Cost discipline will be internal and external so acquisitions will not be a priority in the near-term, Bell said. Once the company reaches its targeted leverage ratio, “select” deals “will likely make sense for us again,” he said.
Finally, he said, Leidos will ensure it is “regular and predictable” on its program to return capital to investors.
The rationale for Leidos’ previous acquisitions is sound but in some instances these “have fallen short of plan” and so now the company will focus on obtaining “the value envisioned in our acquisition business cases,” Bell said. A gap between an operating plan and the original business case for acquiring a company is typical, but now the company must take a closer look on how to get the full value it expects from these deals, he said.
Leidos’ security detection business, which includes legacy holdings and products acquired from
L3Harris Technologies [LHX], is a case in point. The acquired portions of the business include aviation security systems but sales and the supply chain suffered in large part to the COVID-19 pandemic, which sharply curtailed air travel, delaying security upgrades by airport authorities and governments.
The company also won new business for border security inspection systems with the Department of Homeland Security but the program has been slow to roll out.
Growth in the security detection business has improved the past two years and the company expects continued improvement, Chris Cage, chief financial officer, said during the call. Leidos is also doing more in-sourcing to help with supply chain challenges in the security business, he said.
Bell also said that Leidos plans to expand its security detection business into new markets “at very good margins.” Data center protection is one such market, Cage said.
Regarding meeting financial commitments, Bell said “The team and I have had a series of candid conversations in this regard” and have agreed to that it will fulfill these commitments.
“I call this simply a promises made, promises kept philosophy,” he said.
To improve win rates and grow the backlog, Bell said the company to needs to be honest with itself in terms of where it has “differentiated capability” that the market wants and where it does not have these capabilities.
“As such, we will be candid with ourselves about where we have a differentiated capability that the market recognizes and resources appropriately and where perhaps we find we do not enjoy troop differentiation. We will ask ourselves some honest probing questions courageously acting on their answers.”
On the plus side, Bell lauded the company’s talent base, the speed and scale at which it is able to meet its customers’ needs, and technology differentiators such as artificial intelligence, secure software, cybersecurity, and signal processing. He called these differentiators “golden bolts” that Leidos will leverage for its customers.
In the second quarter, Leidos reported higher earnings and sales driven by top-line gains across its operating segments and improved operating earnings in the Defense Systems and Civil segments.
Net income increased 22 percent to $210 million, $1.50 earnings per share (EPS), from $172 million ($1.24 EPS) a year ago. Excluding certain costs such as acquisition, integration, restructuring, asset impairment charges, and amortization of acquired intangible assets, adjusted earnings of $1.80 EPS handily beat consensus estimates by 23 cents per share.
Sales in the quarter increased 7 percent to $3.8 billion from $3.6 billion with 6 percent of the growth organic.
Based on results so far this year, Leidos increased its outlook for sales to between $14.9 billion and $15.2 billion from prior guidance of between $14.7 billion and $15.1 billion. Adjusted earnings are still expected to range between $6.40 and $6.80 EPS, but the company did widen its adjusted operating margin outlook to between 10.1 and 10.5 percent, 20 percent lower than the prior forecast on the low end of the guidance due to “variability” in the security business, Bell said.
Free cash flow in the quarter was $124 million and orders totaled $2.9 billion. Total backlog stood at $34.2 billion, down a percent from $34.7 billion a year ago.