Company Overview: Leidos Holdings, Inc. is a global science and technology company. The Company provides technology and engineering services and solutions in the defense, intelligence, civil and health markets. Its segments include National Security Solutions (NSS), Information Systems & Global Solutions (IS&GS), Health and Infrastructure (HIS), and Corporate and Other. The NSS segment provides a portfolio of national security solutions and systems. The IS&GS segment focuses on providing information technology, management and engineering services to civil, defense and intelligence agencies of the United States government. HIS segment serves customers, including the United States federal government, state and local governmental agencies, foreign governments, healthcare providers and commercial enterprises. Its infrastructure business is focused on integrating and protecting physical, digital and data domains. The Corporate and Other segment includes the operations of various corporate activities.


LDOS Details

Efforts on developing and transitioning a modernized network for global Naval operations: Leidos Holdings, Inc. (NYSE: LDOS) provides solutions and services to solve the world’s toughest challenges in the defense, intelligence, homeland security, civil, and health markets, and had derived over 81% of their total revenues in fiscal year of 2016 from contracts with the U.S. Government. LDOS primarily supports the federal government's evolving information technology (IT) needs. The group merged with the Information Systems & Global Solutions business of Lockheed Martin Corporation on August 16, 2016, in a Reverse Morris Trust transaction. The acquired IS&GS Business was renamed Leidos Innovations Corporation. Due to this transaction, the group was said to incur acquisition and integration costs of $21 million and $56 million during the three and nine months ended September 29, 2017, respectively, and $44 million and $68 million during the three and nine months ended September 30, 2016, respectively. They forecast to incur a further integration cost in connection with the Transactions through fiscal year 2018. On the other side, recently, the group teamed up with IBM, Unisys, and Verizon Enterprise Solutions to pursue the U.S. Navy's Next Generation Enterprise Networks Re-compete (NGEN-R) Service Management, Integration and Transport (SMI&T) program. NGEN-R SMI&T is aimed at offering IT and support services to the Navy Marine Corps Intranet (NMCI), Marine Corps Enterprise Network (MCEN), and the Outside of the Continental United States (OCONUS) Navy Enterprise Network (ONE-Net). The group’s notable wins include a $684 million single award task order from their Civil segment awarded by the Department of Homeland Security to provide operations, maintenance, security and optimization, as well as other services supporting the managed networks under the Secure Enterprise Network Systems, Services and Support or SENS3 Program.
 

3Q FY17 Performance and Outlook (Source: Company Reports)
 
Decent third quarter performance: For the third quarter of 2017, the group reported a revenue rise of 34% year on year (yoy) to $2.5 billion while the nine months ended on September 2017 revenues rose 71.3% yoy to $7.654 billion. Major contributor of this rise in the given periods has been the acquired IS&GS Business ($220 million and $1,213 million, respectively), coupled with growth in certain airborne programs, which partly offset a contract write-up during the third quarter of fiscal 2016 that did not recur in fiscal 2017 and certain completed contracts. The group delivered adjusted EBITDA margins of 10.9%. As per their core Defense Solutions performance, the revenues for the segment rose 12% yoy to $1,201 million but the operating income margin fell to 6.7%, against 9.2% in the prior year quarter. On a non-GAAP basis, operating margin for the quarter was 8.4%, compared to 9.6% in the prior year quarter, impacted by a contract write-up on a certain contract in the prior year quarter that did not recur in the current period. The group reported $0.95 of non-GAAP diluted earnings per share, and generated $268 million of cash from operations, enabling them to repay $125 million of debt and cut their leverage ratio to the target of 3.0 times.
 

Comparative third quarter performance (Source: Company reports)
 
Efforts in relation to diversification: Leidos Holdings is diversifying their business composition. Their diversification was enabled through the IS&GS transaction, enhancing their exposure to civil as well as health markets. The group has leveraged their scale not only within each of the three market segments, but also across the organization. They won a follow-on contract with the Social Security Administration with a ceiling value of $2.3 billion under the health segment. Under this 10-year IDIQ, the group would offer lifecycle activities for software improvement, engineering and management support, database data and systems administration, as well as security support. As per the Health segment performance for the third quarter of 2017, the revenues rose 55% yoy to $464 million boosted by IS&GS Business. Consequently, the Health operating income margin enhanced to 13.6%, from 9.3% in the prior year quarter. On a non-GAAP basis, operating income margin for the quarter rose to 16.4%, from 12.3% in the prior year quarter, driven by better margins on certain IS&GS contracts. With regard to the Civil segment performance, Civil revenues rose 50% yoy to $838 million against pcp driven by IS&GS Business. Civil operating income margin fell to 6.0%, from 6.8% in pcp. On a non-GAAP basis, operating income margin rose to 11.2%, from 9.3% in pcp.
 

Health segment performance (Source: Company reports)
 
Balance sheet position: The group continues to focus on their internal growth initiatives, including internal R&D, unit proposal activities as well as innovative yet cost-effective technical solutions. The group is expanding on capital deployment, to reach their target leverage ratio during the last quarter. They had $287 million in cash and cash equivalents as of September 2017 and further got a revolving credit facility which could offer up to $750 million in additional borrowing. As of September 29, 2017, and December 30, 2016, they had outstanding debt of $3.1 billion and $3.3 billion, respectively. They prepaid $105 million and $130 million during the quarter and nine months ended September 29, 2017, respectively. The group also paid dividends of $48 million and $150 million during the three and nine months ended September 29, 2017, respectively, and $48 million and $94 million during the three and nine months ended September 30, 2016, respectively. The group is aiming to meet their liquidity needs in the next twelve months including servicing their debt, through cash generated from operations.
 
Outlook: The group upgraded their 2017 outlook with revenues expected to be in the range of $10.1 billion to $10.4 billion, while adjusted EBITDA margins were upgraded to be in the range of 10.2% to 10.4% against the prior range of 9.8% to 10.2%. Non-GAAP diluted earnings per share from continuing operations would now be in the range of $3.60 to $3.75, as compared to their earlier range of $3.45 to $3.60. The group also sees their restructuring program to last through fiscal 2020, and forecasts to incur a total of over $90 million in connection with these restructuring activities. On the other hand, cash flows provided by operating activities from continuing operations for FY17 have been set at or above $490 million, up from previous guidance at or above $475 million.
 
Stock performance: The group’s major business is dependent on the overall level of U.S. Government spending, especially on national security, homeland security and intelligence, and the alignment of their service and product offerings and capabilities with current and future budget priorities of the U.S. Government. On the other hand, during May 2017, Congress approved an Omnibus Appropriation bill for the 2017 government fiscal year enabling a discretionary funding for the federal government for the remainder of the fiscal year ending September 30, 2017. For fiscal year ending September 30, 2018, Congress has not enacted any of the 12 appropriations bills and thus no full fiscal year appropriation has been enacted. Since October 1, 2017, the government was operating under a continuing resolution which was to expire on December 8, 2017. Despite being a major international federal IT solutions and service providers, the group’s merger with Lockheed Martin's former Information Systems & Global Solutions Business placed them to offer a cost-effective, agile, and 'speed to mission' capabilities. While there was quarterly bookings volatility, the group saw a better level of award activity during the third quarter of 2017, leading to their 1.2 book-to-bill ratio in the quarter and drove an end-of-quarter backlog position of $17.7 billion. They got net bookings worth an estimated $3.1 billion and $7.4 billion during the three and nine months ended September 29, 2017, respectively, against the $2.9 billion and $5.1 billion for the three and nine months ended September 30, 2016, respectively. The total backlog as at September 29, 2017 included $163 million of benefit from foreign currency movement between the U.S. dollar and the British pound. The shares of LDOS rose about 28.73% in the last one year (as of February 14, 2018) and we believe there is more room for growth given high-value contracts and other catalysts pumping up the dividend scenario. This Fortune 500® information technology, engineering, and science company, was also recognized by the Ethisphere Institute, a global leader in defining and advancing the standards of ethical business practices, as one of the 2018 World’s Most Ethical Companies. It was also recognized as a 2018 Top 100 Global Technology Leader by Thomson Reuters. We recommend a “Buy” on the stock at the current price of $65.73, ahead of their quarter four earnings’ result due for release on February 22, 2018.
 

LDOS Daily Chart (Source: Thomson Reuters)

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