Greetings, and welcome to the Leidos Q2 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] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr.
Stuart Davis, Senior Vice President, Investor Relations. Please go ahead..
Thank you, Hector, and good morning, everyone. I would like to welcome you to our second quarter fiscal year 2021 earnings conference call. Joining me today are Roger Krone, our Chairman and 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 presentation slides that we will use during today’s call. Turning to Slide 2 of the presentation.
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, as shown on Slide 3, during the call, we will 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 will turn the call over to Roger Krone, who will begin on Slide 4..
Thank you Stuart and thank you all for joining us this morning for our second quarter 2021 earnings conference call. Our results in the second quarter reflect our leadership position in the government technology market.
I’m tremendously proud of the way Leidos has responded throughout the pandemic as our employees and business partners continually delivered for our customers and shareholders.
While we remain vigilant with the recent uptick in COVID-19 cases, Leidos is stronger than ever, with new quarterly record levels of revenue and backlog, consistent with our industry-leading organic growth. As I look at the quarter, four messages stand out. First, our strong financial results demonstrate that our strategy is working.
Second, our business development momentum is setting the stage for future growth. Third, we are effectively deploying capital to broaden our offerings in attractive markets. And fourth, we are building an engaged and effective workforce. I will now drill down on each of these four key messages.
Number 1, our strong financial performance was highlighted by double-digit organic growth and adjusted EBITDA margins above our long-term target. Revenue for the quarter were $3.45 billion up 18% from the prior year on a total basis and up 16% organically.
Adjusted EBITDA margins of 10.4% were in line with guidance and above the long-term target we established two years ago. After adjusting for the one-time gain in the second quarter of 2020, non-GAAP diluted EPS was up 37%. These results didn’t just happen rather they are a direct result of our strategy.
We have differentiated ourselves within the market through scale, which creates a more competitive cost structure and expanded capability to take share and position in vital markets. We have also leveraged our cost structure to make key technology investments, which further separates us from our peers.
Number 2, our business development engine continued the momentum that is driving our industry-leading organic growth. We achieved net bookings of $3.8 billion in the quarter, representing a book-to-bill ratio of 1.1. Our 14th consecutive quarter with a book-to-bill ratio of one or greater. Our trailing 12-month book-to-bill ratio is now 1.2.
As a result, total backlog at the end of the quarter stood at a record $3 billion, which was up 9% on a year-over-year basis. In our Health segment, we were awarded a new fixed-price contract with a ceiling value of almost $1 billion to improve the health of military service before, during and after deployment.
Under this contract, known as the Reserve Health Readiness Program, or RHRP. We will provide physical, mental health and dental assessments along with laboratory and diagnostic services supported by a secure IT infrastructure and customer service call center.
America’s more than one million reserve component personnel stand ready to support and defend our nation when it is called upon. It is our honor to support them.
In our Defense Solutions segment, the Transportation Security Administration awarded us a $470 million prime contract to integrate transportation screening equipment at airports all around the country.
Based on our policy, we only booked a small initial task order in the quarter, although we expect to achieve the full value over the life of the contract. This work is a reconfiguration of work we have been performing for over 12-years. And we also maintain screening equipment for TSA at all U.S.
federalized airports, helping TSA ensure freedom of movement for people and commerce as one of the core ways Leidos is making the world safer, healthier and more efficient.
In our Civil segment, the Federal Aviation Administration notified us that they have given us initial tasking as part of a long-term extension for the continued systems integration sustainment and enhancement of the En Route Automation Modernization, or ERAM system.
The ERAM system is critical for operations in the national aerospace system and at the 20 air route traffic control centers in the Continental U.S. We didn’t book anywhere close to the $6.8 billion ceiling value, but it speaks to the confidence that the FAA has in Leidos.
We expect to begin the 2022 government fiscal year with a continuing resolution, but customers will still be able to fund work in critical needs areas. Our positive outlook is bolstered by the level of proposal activity. At the end of the quarter, we had $49 billion in submits outstanding of which $35 billion is new work for us.
Number 3, we are deploying capital to complete our offerings in attractive markets to spur profitable growth. In May, we completed the acquisition of Gibbs & Cox, which brings us world-class naval architecture design and engineering. They design 68% of the Navy’s current surface combatant fleet and are truly a national asset.
This deal enhances how we are viewed across the Navy and opens up significant market opportunity for us. Our strategic planning process had identified maritime as an attractive market where we were underpenetrated.
To enable synergies, especially around unmanned surface and subsurface systems, Gibbs & Cox will be combined with Leidos’ Maritime Systems division and operate under Dynetics within the Defense Solutions segment. In addition, we are seeing early returns from our 1901 Group acquisition, which we closed in January of this year.
Most directly, 1901 is providing significant support to the NGEN program transition and operations. They have significantly expanded their workforce, growing the current enterprise IT operations center in Virginia and accelerate the establishment of new NGEN service desk locations in San Diego, Norfook and Boise.
1901’s platform delivered IT services made them the best choice for the program’s requirements in this area. 1901 was also instrumental in securing a 125 million follow-on contract with the Bureau of alcohol, tobacco, firearms and explosives for managed IT services.
1901’s strong customer relationships with the ATF, coupled with their efficient as-a-service delivery model, made them key to the bid and execution strategies. In addition to deploying capital to spurn growth, we were also committed to returning capital to shareholders. To that end, our Board just approved a 6% increase to the quarterly dividend.
This increase reflects the confidence of the Board of Directors and the management team in the quality of our earnings and our ability to generate cash. Number 4. This is a people business, and this quarter offered further proof that we are an employer of choice that can attract the workforce needed to meet our financial commitments.
During the quarter, we hired more than 4,500 people and at the end of the quarter, we were more than 42,000 strong. Our headcount grew 6% sequentially and 11% year-over-year. Our ability to attract top talent in this manner is important as we staff up to successfully execute the new programs.
One of the reasons we are attractive to job applicants is that we invest in talent management and career development. We regularly review talent and plan development actions including rotations at all levels throughout the company.
As an example, Executive Vice President, Jim Cantor, recently announced his intent to retire after his distinguished 31-year career at Leidos. This enabled us to reconfigure our team to optimize performance given our rapid growth and the changes in market priorities.
I asked Vicki Schmanske who is leading our intelligence group to assume the new role of Executive Vice President, Corporate Operations. In her new role, Vicki will drive operational performance and implementation of strategic functional initiatives.
Roy Stevens who led business development and strategy succeeded Vicki as the President of the Intelligence Group. In addition, I asked Chief Human Resources Officer, Paul Angola, to lead a strategic effort to chart our way forward in the national security space market. These changes will help us prepare for an uncertain future.
A few weeks ago, we kicked off the $1 million move-the-needle sweepstakes to encourage our employees to get vaccinated against COVID-19 and Hasson are coming back together. At the time, all of our facilities were open and all vaccinated individuals were able to work without a mask. A lot has changed in the past weeks.
The highly contagious delta variant and the infection trends are disturbing. As we have throughout the pandemic, we will comply with all CDC guidelines, and most of our facilities will require masks regardless of vaccination status. While we do not expect that our customers will be shutting down their offices again, we cannot be certain.
In the face of that uncertainty, we have decided to keep our current forward guidance in place and Chris will walk you through that in more detail. For me, part of returning to normal is being able to get together face-to-face with our investors and analysts. It is our intent to host an Investor Day in New York on October 7th.
We have a compelling story to tell, and we look forward to doing just that. We will closely watch for COVID protocols from New York City and update you if our plans change. Finally, Frank Kendall has stepped down from our Board to serve as the Secretary of the Air Force.
I want to thank Frank for his service to Leidos and more importantly, to the Air Force, the Department of Defense and the nation. I will now turn the call over to Chris Cage. I’m delighted to have Chris step up to the CFO role and join us on these calls..
delivering on our financial commitments, integrating acquisitions and prioritizing spending on investments to execute our strategy. With that, let’s jump right into the second quarter fiscal year 2021 results.
Beginning with the income statement on Slide 5, I will first run through the financial results at the corporate level, then turn to the segment level to address the primary revenue and profitability drivers. As Roger said, the highlight of the quarter was our organic growth, which is truly unprecedented in our industry at our scale.
Revenue quarter were $3.45 billion up 18% compared to the prior year quarter. Excluding acquired revenues of $58 million, revenues increased 16% organically. Notably, revenues grew organically across all three reportable segments.
The organic growth is somewhat inflated by the drop in the revenues last year as a result of the pandemic when for example, our VA disability exam business was almost entirely shutdown. Even if we add back the 132 million direct pandemic effect in the prior year, organic revenue growth was still 11%.
Adjusted EBITDA was 359 million for the second quarter, which was up 5% year-over-year. Adjusted EBITDA margin decreased from 11.8% to 10.4% over the same period. Excluding the VirnetX gain from the prior period, adjusted EBITDA margin increased by 140 basis points in the quarter.
This was primarily due to strong program management, higher volumes on some fixed price programs and better direct labor utilization. Non-GAAP net income was 218 million for the second quarter, which was down 2% year-over-year and non-GAAP diluted EPS for the quarter was $1.52, also down 2% compared to the second quarter of fiscal year 2020.
Excluding the impact of VirnetX gain from last year’s results, non-GAAP diluted EPS was up 37%. Our effective tax rate on non-GAAP income in the quarter was 24% compared to the 22% we anticipated for fiscal year 2021, this negatively impacted non-GAAP diluted EPS by $0.04. The tax rate increase was primarily across our international business.
The largest single driver was that in Q2, we recognized the full impact of a recently enacted increase in the U.K. corporate tax rate from 19% to 25%. Now for an overview of the segment results on Slide 6, Defense Solutions revenues increased by 14% compared to the prior year quarter.
Excluding the acquisitions of 1901 Group and Gibbs & Cox, organic revenue was up 12%, primarily from ramping up recent contract wins such as NGEN and increased weapon systems development within Dynetics.
Civil revenues increased 5% compared to the prior year quarter, with about half coming from the SD&A acquisition and half driven by increased demand on large programs such as Hanford site integration. Health revenues increased 62% compared to the prior year quarter, and all of that growth was organic.
We had a large year-over-year increase on the DHMSM as well as a nice ramp on the new Military and Family Life Counseling program or MFLC. The largest increase, though, was in the VA disability examination business in our QTC subsidiary.
Remember, this was the business hardest hit by the pandemic in the year-ago quarter and now volumes are higher than ever as we continue to work through the backlog of exams. On the margin front, Defense Solutions non-GAAP operating income margin for the quarter came in at 8.3%, which was up 20 basis points compared to the prior year quarter.
Civil non-GAAP operating margin declined from 12.9% in the prior year quarter to 9.1% as we had fewer deliveries of our border and port security systems and airport screening systems. Finally, and most significantly, health non-GAAP operating income margin for the quarter was up to 17.8% compared to 5.3% in the prior year quarter.
This quarter’s strong margin performance benefited from the significantly increased revenue volume, but the year-over-year improvement was enabled by the strategic investments we made a year-ago to keep our workforce in place and ready to meet the coming customer demand.
Turning now to cash flow and the balance sheet on Slide 7, operating cash flow for the quarter was 17 million and free cash flow, which is net of capital expenditures, was a usage of four million.
During the second quarter, we settled the accounts receivable monetization program, which negatively affected our operating and free cash flow by $94 million. On a year-to-date basis, the AR monetization program is neutral to cash flow, and we do not plan to sell any more receivables.
During the quarter, we used working capital to fund the start-up of new programs and the expansion of existing programs and drive strong organic growth. You can see this impact most clearly in the drawdown of advanced payments compared to last year.
Cash generation from the business segments was right on plan for the first half of the year and actually ahead of last year. But that performance is overshadowed by one-time non-operational cash benefits in the first half of 2020.
These include 225 million from the AR monetization program; 85 million from VirnetX; 48 million in CARES Act tax deferrals; and 103 million in lower cash taxes, which is just a timing issue. During the second quarter, we paid down 27 million of debt and returned 48 million to shareholders in quarterly dividends.
As laid in Friday’s 8-K, our Board of Directors approved a 6% increase in the dividend beginning in September. This is our first increase in two-years and reflects our confidence in the future outlook and commitment to shareholder returns.
In addition, we paid net consideration of 376 million to acquire Gibbs & Cox, which positions us to provide a broad set of engineering solutions to the U.S. and international navies.
Gibbs & Cox is contributing a little more than 100 million in revenues this year at margins above the Defense Solutions segment average, given its higher proportion of fixed price work. To finance the transaction, we borrowed 380 million with a one-year maturity at very attractive terms, no more than LIBOR plus 113 basis points.
As of July 2, 2021, we had 338 million in cash and cash equivalents and 5.1 billion of debt. Last month, we established a commercial paper program for short-term liquidity management. Commercial paper will give us more flexibility at a lower cost than selling accounts receivables.
Commercial paper is only available to us because our debt is investment grade, and we view our investment-grade rating as a strategic asset. Over the remainder of the year, our primary capital deployment priority will be debt pay down as we return to a normalized leverage ratio of three times.
We remain committed to our long-term balanced capital deployment strategy, which consists of being appropriately levered and maintaining our investment-grade rating, returning a quarterly dividend to our shareholders reinvesting for growth, both organically and inorganically and returning excess cash to shareholders in a tax-efficient manner.
On to the forward outlook. As shown on Slide 8, we are maintaining our guidance for fiscal year 2021, including revenue between 13.7 million and 14.1 billion, adjusted EBITDA margin between 10.5% and 10.7%; non-GAAP diluted earnings per share between $6.35 and $6.65; and operating cash flow at or above 875 million.
As the year progresses, we normally tighten our guidance ranges, but there are a lot of forces at play, including worsening of the COVID situation with a more contagious Delta variant in stagnation in vaccination rates as well as ongoing challenges in the global supply chain, especially around computer chips.
On revenues, NGEN is ramping well, but this is still a new customer and new contract. So we don’t want to have an established history of order flow and don’t want to get ahead of ourselves.
The Intelligence Community award decisions have slowed noticeably, and we are also incrementally more cautious on the bounce back of the international airport screening market. So we are not forecasting a return to growth there until 2023.
The Gibbs & Cox acquisition should keep us comfortably in our revenue range, but it likely won’t put us above the range. We expect revenue to grow fairly linearly through the back half of the year from Q2 levels.
Growth drivers in the third and fourth quarters include the full contribution of Gibbs & Cox, the continued ramp on NGEN, MFC and several other programs. Towards the end of the year, we expect the VA medical exams will begin to return to their pre-pandemic levels.
On EBITDA margins, year-to-date performance in the second quarter was 11.1% to land in the guidance range for the year, adjusted EBITDA margin for the back half of the year will be around the same level as this quarter. Non-GAAP diluted EPS will generally follow revenue and margin.
However, we are now forecasting the FY 2021 tax rate to be between 23% and 23.5% instead of our original 22% forecast, which slightly outweighs the accretion from Gibbs & Cox.
In addition to the international tax headwinds I mentioned earlier, we are now forecasting a lower deduction for share-based compensation based on stock price performance over the first half of the year. Finally, we expect cash flow to follow our normal pattern and accelerate in the back half of the year to land us at the guided level.
Over the past five-years, we have generated an average of 65% annual operating cash flow in the third and fourth quarters. That pattern will be slightly more pronounced this year as a result of the working capital that we have devoted in the first half of this year to drive 17% year-over-year growth.
We have a detailed execution plan to achieve our operating cash flow guidance. And with that, I will turn the call over to Hector so we can take some questions..
Thank you. [Operator Instructions] Your first question comes from the line of Sheila Kayaglu with Jefferies. Please proceed with your question..
Hi good morning Roger. And welcome, Chris. Thank you both. So maybe, Roger, if you could comment on your Intel business, how large is it? And you mentioned some delays there, Booz I think, was down mid-single digits in the quarter.
So maybe what is going on with the Intel customer specifically and what sort of delays are you seeing?.
Well, it is a little bit larger than two billion. And of course, it is in our Defense Solutions segment, so we don’t really spike it out. The good news for us is, after the quarter, we did win a recompete which is below one billion.
But what we have seen overall is it just has taken them longer to get through their acquisition process and awards, recompetes, new business that we had put in our plan have taken literally months or quarters to come to fruition.
And what that has meant for us and for others in the industry rather than booking a full increment of a recompete, we are getting shorter extensions. And so it is not really contributing to the increase in backlog. But in the last quarter or two, we really haven’t lost a significant amount of business.
It has just been like a lot of things in COVID, things have just been moving to the right..
Okay and then maybe one quick one on margins. You guys did really well with first half margins up 11% - I’m sorry, 11% EBITDA margins, and your implied guidance is 10%.
Is this like the start of Chris’ conservatism or is that maybe mostly due to the civil margin impact because that looked like it was down in the quarter, and I think you mentioned due to the security business..
Sheila, this is Chris. Thank you. And no pattern of conservatism here, but we laid out some reasons to be cautious, right. And so there are some unknowns. Last year with COVID, things whipsawed a little bit. So with Delta variant, we are being conservative there.
We laid out for Civil, of course, we are expecting some uplift overtime from the security products business and not just the aviation side, but the ports and borders, which that business has performed very well for us on a legacy basis. So there are some puts and takes.
We are still intending to increase our level of investment on research and development. We built that into our plan all year long and so some of that is programmed in for the back half of the year, but we want to make sure that we can deliver on these commitments..
Thank you..
Your next question comes from the line of Robert Spingarn with Credit Suisse. Please proceed with your question..
So Roger, maybe Chris, you talked about your attention to the top-line guidance a couple of times here so far, but there are a bunch of moving pieces. And I was wondering if we could size some of this. Would it be right to characterize the naval architecture business is around I don’t know, 80 million, 90 million a quarter..
No. We would say maybe 100 for the half. So remember, that is about what we get. So it is about a half a year, call it, 100 million, maybe a little bit better than 100 million, and it is growing. But for the half that we will book rounded to 100 million..
Okay. And that is what you are thinking in terms of maybe offsetting downside from COVID? I know COVID is a tough discussion to begin with.
But how are you thinking about that? Maybe another way to ask this, Roger, is have your organic growth targets changed since Q1 for the three segments?.
Well, you know we are talking 139..
I’m not just talking about that..
Yes. I mean not appreciably - hey Robin you and I think the other folks on call know where we were a year-ago, and we thought we made a reasonable change a year-ago. And we sort of walked into the second wave. And I think we all learned that this COVID thing is unpredictable.
Throw on to that the shortage of computer chips and which - and we usually get a lot of material deliveries in the second half. And although we have seen some lengthening in the supply chain, we don’t see any shortages yet. But you all have taught us a great lesson in the last 12-months. And I kind of like where we are.
Yes, Gibbs & Cox gives us a little bit of lift. But there is a ton of uncertainty out there in the next six months..
Yes, Robin, this is Chris. Just to add on to that. Obviously, we do detailed forecasts and ops reviews quarterly with all our business lines, and there is always movements, right, across the portfolio. Roger just talked about the Intel delays.
And so that might have been a business area where some of the things that we put into the pipeline haven’t come out yet. We were hopeful that some of those would and potentially give some uplift. None of those have been lost.
But there is always small movements within the portfolio within $13.9 billion midpoint that we are driving towards and so the Gibbs & Cox piece potentially helps offset some of that or give us some capacity for downside risk given the COVID situation..
Okay. I guess what I’m really looking for is because last year was so challenging, and this year, you are catching up a lot, and you have a lot of good businesses that are growing. I mean, this obviously is a high growth year. You are the highest grower in the sector, as we have discussed.
Maybe high level, Roger, looking into the future, once things normalize, how do you see the growth patterns in the business?.
Well, we still see a strong growth but not at the level that we have just demonstrated. At our investor meeting two-years ago, we kind of talked about five, right. And we will talk about that again in October. So clearly, we are comfortable with five.
But what we have been doing over the last couple of quarters is really unprecedented, and I don’t expect to paint another quarter like we did.
Some of that certainly year-over-year is COVID recovery, but we have enjoyed a significant number of wins and a high percentage of our competes so we are still very bullish on our long-term growth prospects, but not at the double-digit level..
Okay. Thanks very much..
Your next question comes from the line of Cai von Rumohr with Cowen. Please proceed with your question..
Yes. Terrific. And so Roger, you won AEGIS, but it is under protest. Maybe update us on that. And on your larger outstanding bids, I believe they include in-play, UDS recompete and the 3.5 billion FAA award..
Okay, Cai, thanks and hey good morning. So we won the - it is a NASA bid about - in the order of 2.5 billion. It was protested by the incumbent as it seems everything is nowadays, NASA is taking corrective action. And so it is a little hard to forecast what the outcome will be.
History has told us NASA takes corrective action, they make another award decision and then, of course, usually that is followed by another protest and those tend to last kind of 100 days. And so it may take them another three, four weeks to do their corrective action and then you tack another three-months on the back of that.
So we suspect we will be talking about NASA ages through the third and fourth quarter, unfortunately. On DAS, it is a big contract up at DISA. We are hoping it will be a fourth quarter award. It could easily slide into first quarter. And I would suspect, Cai, that will be protested 1 way or the other.
The UDS bid, which is at NGA, which is in the nominally four billion to five billion, a significantly large bid, we expected that to come out July and August. There are some other things going on at NGA, which is in the Intel group, Sheila’s question, which may cause that to be delayed. It could happen in August, it could happen in September.
Frankly, the acquisition team at NGA is really busy. And when they get around to clearing the award, they will make the award. We think it is third quarter, but these things become ever increasingly hard to forecast. But those are the big ones that are out there. There is some other things that are down in the one billion level..
Great, thank you. And then if I could follow-up on Sheila’s question about margin. It sounded like you went out of your way to remind people that your long-term target is 10%, it is not 10.4%. I guess as we just look at next year, I would assume health the margin has to be down because you don’t have the VA catch-up.
If you get AEGIS, that is below average so that I assume civil also would have downward pressure year-over-year. So is that calling out the 10% just to be conservative or is there a real concern that realistically, there is no way 10.5% is kind of anything you could do on a sustainable basis..
Go ahead, Chris..
I’m sorry, Roger. So Cai, Chris here, I just was going to jump in on that. So first of all, we were trying to send a signal about 2022 yet, right. That is what we will lay out when we get to Investor Day in October. But there is more going on to what you pointed out, and those are various due observations.
Number one, Roger talked about 1901, the contribution that is making to our portfolio. And that would really be an enabler across not only the defense opportunities in enterprise IT, but also into the Civil segment and others to help us deliver those capabilities more cost effectively and drive margin uplift.
So we see that as something that will help us there.
Obviously, in the Civil segment, margin will ride up with the recovery in our security products business and not just the aviation side, but as I mentioned, ports and borders and there are opportunities, whether it is within the infrastructure bill or otherwise with our customers internationally for that line of business that we are very bullish on.
So those things would help us lift margins in that area, and we do have to be prepared for health margins moderating back down a bit as the exam backlog works its way down. But again, that will still be a robust part of the portfolio on margins. So more to come in October, but I don’t think you should read in that we are resetting to 10% longer term..
Thank you very much..
Your next question comes from the line of Gavin Parsons with Goldman Sachs. Please proceed with your question..
Hey good morning. Roger, I just wanted to clarify your organic growth comment in response to Rob’s question. You said at the last Investor Day, you talked about 5%, you are comfortable with that.
Without getting ahead of Investor Day targets, can you just clarify if you mean you think you can continue to grow 5% on a multiyear outlook?.
I want to be absolutely clear. The long-term outlook that is out is what we gave at the investor conference, gosh, in May two-years ago, and we raised it from three to five, okay. We have done nothing to change that, okay. And that is what I was just trying to articulate to Rob.
That being said, our organic growth, frankly, our total growth has been really remarkable. And our book-to-bill, it has just been great. I mean the team has done such a great job. I’m not going to update the 5% until October. But I have tried to give reasons why there should be a lot of confidence at five or perhaps better.
So Gavin, that is about as far as I can go..
Okay. No, that is great. I appreciate the clarification. I just wanted to make that clear. And then Chris, anything you could do to help us quantify the health care exam contribution that business is running 30% above 2019 levels, but obviously, you have some other growth drivers in there.
So any sense of what maybe that business has grown versus 2019, excluding the lumpiness in exams?.
Yes. Gavin, I mean, as you can appreciate, there is some sensitivities on getting too far down into the portfolio competitively or otherwise on that. But that is not the only thing that is going on in health. That is the point we wanted to make. We have told you for a long time that the DHMSM program would be ramping up, it has.
That team is performing exceptionally well. MFLC is really on a nice trajectory to ramp up, and those margins will be lower than other parts of the portfolio initially, but they will have an opportunity to increase overtime. And we have got zero contribution from RHRP in these numbers, right.
So that will be something that we will look forward to next year to really ramp up as that program gets underway. So the exam business is above historical levels, but quite honestly, that team has delivered so well that the customer is looking to send more work our way overtime.
And so we are prepared to accommodate them in their needs however possible. And so the hope is that we can continue that at a nice clip..
Thank you..
Your next question comes from the line of Matt Akers with Wells Fargo. Please proceed with your question..
Hey good morning guys, thanks for the question.
Could you kind of update what are your latest thoughts on the infrastructure bill in maybe areas where you could see a benefit from that?.
Great question. Of course, we are hoping that there will be a rare show of bipartisan that looks like it is a $550 billion plus over what we would have seen. And there is a lot of focus on your roads and public transit and water systems. But we think broadband, airports, ports, waterways, security equipment.
And then we think there is going to be emphasis on protecting the infrastructure and whether that be cyber security or grid hardening. That is right in our swim lane and then we are really excited about 5G and frankly, 5G really to everyone in the country.
And we think that will spur sort of another big investment in IT and IT technology as the ability of all us the ability of all to function from an edge device. The phones that we have today are just the beginning. When we all have 5G, the functionality that you will carry in your pocket is going to increase by an order of magnitude.
And that with cloud and as a service, we could see that as spurring a whole new round of investment and application, migration, so we are very bullish. Now I will caution everyone, it is our typical federal government authorized appropriate then it gets distributed to the agencies.
They put plans together then they put out RFPs and they have industry days and we bid. And I don’t want to sound too negative here, but it takes a long time for money like that to flow through the system to where we win contracts, we start performing, we turn it into revenue and then finally into cash and earnings.
So it is all positive and it is positive for us, not only because of our Civil group, but really across the board and everything that we do in technology, it is going to be months or years away, but overall positive..
Thanks and I think on the COVID in this latest wave, it sounds like that is a big driver kind of conservative guidance for the rest of the year.
Are you seeing any signs from particular areas that maybe customers are considering closing down locations again or contracts getting delayed or anything that you are seeing there or just is that sort of just cautious in the guidance?.
We haven’t seen customers like we did when we were talking about 360 and the CARES Act and the Intel went to shift work. I will just what we all know, I mean, the President comes on national TV and talks about a mask mandate, we all stand up and listen.
We are essentially going back to a mask mandate according to the CDC guidelines, and we will expect all of our customers to do that. A bigger concern for us is really what is going on outside of the U.S. And as you know, we have significant operations in Australia, the U.K., the Middle East. And they are hunkering down again.
In Australia, not only is it difficult to get in the country, it is difficult to get around the country to go from Melbourne, to Canberra and to Sydney.
And I think Chris addressed it well, but our SD&A business and certainly the part that we acquired is heavily dependent on international business, which is dependent upon tariffs on airline tickets and when the volume is down, the money is not there.
And although we have not lost any significant competitions in the SD&A business, we have seen many, many canceled and delayed. So I think the impact for us will be in our Civil segment in the business that we refer to as security detection and automation..
Got it, thank you..
The next question comes from the line of Peter Arment with Baird. Please proceed with your question..
Hi good morning. You actually have Eric Ruden on the line for Peter today. Maybe just a quick one for me. With a lot of the focus across many industries today being on rising input costs and labor being the lion’s shares of yours. Are you seeing any pressure there, I know you mentioned the 4,500 new hires.
So any color on how you are offsetting these headwinds in the current environment and then how much additional staffing is needed near-term?.
Let’s see. It is sort of a mixed answer. We refer to them as unicorns. So someone with a lifestyle polygraph, a security clearance and can program in a computer language called Python in a national capital region around D.C. Yes, we are seeing a lot of competition for that person.
And in order to get the staff that we need, we have to compete, and that is driving up labor in those areas. In other areas, there is a lot of people available. We have been able to meet our hiring goals.
And of course, as we have said on this call, we have a strategy to de-concentrate our work in the national capital region and move to areas of the country where the workforce is more readily available.
Our 1901 acquisition, which I know we haven’t talked a lot about, has a significant presence in Blacksburg, and a great relationship with Virginia Tech. And that was just one more reason why it was attractive to us, and it opens a new workforce for us. We have a software development center in Morgantown, at West Virginia University.
We have one in Charlesville at UVA, and now we have one in Blacksburg. Overall, we are expecting to hire maybe a number that is in the 9,000 to 10,000 new and we are at the I think I said 4,500. We are a little bit better than that now, because of the Navy NextGen staffing, which has continued to go very, very well.
And we have enjoyed what we call incumbent capture where people who are under contract with the prior contractor have elected to come to work at Leidos. So we are actually significantly above that number.
And so we are on-track to meet our hiring goals but there is always that specific individual, you know a PhD and radiology that is difficult to find, especially if you are geographically limited as you often are in the Intel business..
Okay. Thanks that is very helpful. That was the one for me..
Your next question comes from the line of Tobey Sommer with Truist Securities. Please proceed with your question..
I was hoping you could speak to how you anticipate wage inflation, should it sort of materializing broadly impacting the business and when you described your answer, could you touch on the different contract types to the extent that, that could be informative?.
Yes. Tobey, I will start and Chris can come in with some of the numbers. We have a portfolio mix, which is a little bit - it is almost 50/50. It is a little bit off from that, which is fixed price. And some of our fixed-price work is what we call time and materials, but think of that as fixed rate. Right.
So it is so much per hour and the customer buys a number of hours. And then we have what we call our cost reimbursable or cost type contracts. And I will - let me start very simple and then I will see if I can address your question.
Clearly, on the cost reimbursable work, if there is wage inflation, that essentially becomes a pass-through to the customer. And that is not as - maybe not quite as positive as it sounds because customers live on annual budgets. And if you are a NASA customer, you have X for a program in a given year, you don’t have X plus inflation.
And so if our wages increase inside a budget year, often the customer will have to decrease scope because they don’t have any additional funds to execute the program. And then, of course, on fixed price, we have said, we will do a program or complete a task for a fixed dollar amount.
And the therefore, rely on us to balance the cost per hour with the number of hours. And our challenge, and I think it will be the challenge across the industry, if we see significant wage inflation above what we estimate when we bid, then we are going to have to find new efficiencies in service and delivery to offset that inflation.
We are always trying to do that. That is why sometimes on fixed-price programs, our profit margin might be a little bit better. And we will just have to do more of that.
Part of the again, going back to our 1901 comment, the excitement about 1901 is it has an as-a-service platform, which is really independent on labor, so we charge so much for a service, and we use essentially application IT platform to deliver that.
And there is a lot of opportunity for us to create new efficiencies through the service and delivery model..
And Tobey, this is Chris. Just to add on to Roger’s point, you hit most of the issues here. Every year, we do a detailed pricing build up - multiyear pricing buildup for our indirect and our direct labor costs and certainly contemplate some level of inflation as we build multiyear projections around that.
If it turns out that wage inflation is outpacing what we have estimated, we have an opportunity to refresh that, which we will do, and we will build those costs in. And so you really are just - at any given time, you might win some contracts where you price them with the old rates.
And to Roger’s point, you have to find opportunities to drive efficiencies to protect margins. But on the future bids, we are pricing in what we think it requires to execute the work. So we are very transparent about that with our customers. And we have got good competitive Intel on where we think we need to be on a price to win.
So all those factors play into how do we deliver, how do we win work and how do we maintain the margin profile that we are committing to you..
Yes. Tobey, one additional side. Just because I think it is a really thought-provoking question. One of the things that we have seen is as we mix more college hires and less experienced employees into the mix, what we call labor categories and their wrap rates, they make less.
And we have been thrilled with the quality of our less experienced workforce and their ability to do the job. And that is another lever for us as we increase our college hiring to use more of that newly graduated workforce in key positions..
Thank you very much.
And I wanted to get your perspective on continuing resolution and what sort of the data you might expect that to extend at this juncture?.
Yes. I will be really quick. We want to get one or two more questions in. I think everyone does expect to see at the end of the fiscal year. I’m not optimistic I don’t think we will have a government shutdown. I think we will get through the debt ceiling limit. I don’t know if there is any appetite for that in either side of the aisle.
I would love to be optimistic and say we are going to get a bill before the end of the year, but I’m not. I think we will run a CR through - into the first quarter. Just everything that seems to be going on, that would be my forecast. And what that will do is we all know is the work that is under contract will continue, new starts will get delayed.
By way, new starts are getting delayed anyway. And as we have said again many, many times, I think, in like, what is it, 19 of the last 20-years, we have had a CR. So I don’t see it as a big impact to our business. I would love to see a bill, but we are certainly able to handle a CR as long as it doesn’t go past first quarter..
Thanks, Tobey..
Thank you..
Your next question comes from the line of Joseph DeNardi with Stifel. Please proceed with your question..
Maybe Roger or Chris, just following up on a prior question, enterprise IT has been a big focus for you all and obviously, a lot of success there with NGEN and now AEGIS. I can’t imagine it would be such a focus if that work was dilutive to margins.
So is there a rule of thumb, say, for a 10-year contract when that work becomes accretive? Is it right away? Does it take a few years? Is it not until the end of the contract? How does that work generally?.
You mean accretive to our average margin or accretive to EPS?.
Accretive to your average margin..
Yes. There is not a rule. And really it is customer by customer and competition by competition. We have some programs that start out and they are above our margin. We have other programs, HRP, which is really not an IT program, but RHRP has a six-month very low-level transition built in.
So we won’t see RHRP as accretive to margins until significantly into next year just because of the way the contract is structured. So there is not a particular rule of thumb.
But we have generalized on this call in the past is it takes us a while after we staff up and we have demonstrated performance to be confident and therefore to raise our accrual rate. But I will turn it over to Chris..
No, Joe, I would say usually, we kind of say, give us 1.5 years to two-years. It depends.
What we like about those contracts in general is they are often - whether a fixed unit rate or fixed price and we do think as we understand the environment better, there is opportunities to introduce more efficiencies into the environment and drive savings that way through automation, through as a service, et cetera.
With workforce rebalancing, as Roger indicated, what can you get for lower level employees potentially. So everyone is a little bit different. It depends on whether there is a transition phase, how that was bid, what they are paying you for, so really contract by contract..
Got it. That is helpful. And then, Roger, you said earlier that you can’t necessarily expect to grow 10% every year, which is understandable.
I’m just curious if you see that because you are just trying to manage expectations, which is obviously fair or do you not see the opportunities in terms of taking market share over the next couple of years that maybe you had a few years ago?.
Yes. Joe, it is really more of the former. Without putting too many numbers out there, we intend this year to submit more proposals in aggregate than we did last year, all right.
And we will look at our pipeline, and we have a fairly well disciplined business development process where we go out early five to 10-years, we build a pipeline of potential business. We are not constrained by opportunity.
In fact, what we are trying to do is to call out of our pipeline earlier, those things that are not, if you will, not in our strike zone. So we spend our new business funds more efficiently, but we will submit more proposals this year than we did last year. And clearly, last year, we did more than the year before. So it is really not an opportunity.
It is, gosh, I would love to think we could grow 10% forever that we were sort of a Silicon Valley high-tech startup. And it is just - we have been very, very fortunate and we don’t want to get too far over our skis..
Thank you..
Our final question today comes from Mariana Perez Mora with Bank of America. Please proceed with your question..
Good morning everyone an thank you. Your updated outlook, you mentioned the challenges related to the supply chain and especially the lengthening and the supply chain of computer chips.
Would you mind telling us and giving some color on the impact so far and how should we think about the potential impact in the future?.
I think I understood your question. Let me take a shot at it..
And act so far on the main challenges..
Yes, we haven’t seen a lot. We probably have seen - and we install a lot of end-user equipment as part of several of our programs. And so we buy from all of the household names that you are familiar with.
And what we are talking about silicon wafers that then get converted into processors, both general-purpose processors and application-specific integrated circuits.
What we thought was COVID-related, and we kind of put it into a big category, as we sort of started to come out of COVID, we find that parts of the supply chain shut down in this lower end computer chip market and is not coming back as quickly as anyone thought.
And in fact, in some markets like auto, their concerns, some of - certainly at the wafer level that some of that capacity is not going to come back at all. We have not seen shortages. We have just seen delays. And we are planning a couple of years out.
But we have seen lengthening in - especially for IT equipment, probably in the weeks to a month in some areas and material has an impact on our revenue, both good when it happens and bad when it gets delayed. And it is a part of why we are not touching guidance for the last six-months.
Although we are doing fine now, some of our contracts have significant material purchases planned for the last half of the year. And out of an abundance of caution, we wanted to give you visibility and transparency into our supply chain..
And I think Mariana, it is definitely something we will spend more time on as we build our 2022 plan because, as Roger indicated, we have relationships, key relationships with critical suppliers and we stay abreast of what is going on there. But while the IT component of many contracts isn’t always our highest margin contributor.
It does contribute to revenue. And so therefore, it is fairly integral. So as we get to 2022 planning make sure we have got good line of sight on what the latest expectations are. But this year, with the guidance range we provided, we think we gave ourselves some latitude for some potential delays, modest delays across the supply chain..
Thank you..
Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Mr. Stuart Davis for closing remarks..
Thank you, Hector, for your assistance on this morning’s call. And thank you to all joining in this morning and for your interest in Leidos. We look forward to updating you again soon and especially in October..
This concludes today’s conference. You may disconnect your lines at this time. Thank you all for your participation..