Tom Bell: Yes, and just to pile on that one, Bert, if you don’t mind, so proud of the team. The RFP asked for a transition plan of 60 days. The team accomplished it in 19 days to be fully up and running for the customer in this important part of their value stream. So, just so super excited about the team that was able to lean into that and satisfy the customer quickly out of the blocks.
Bert Subin: Super helpful. Thank you, Tom, and Chris.
Operator: Our next question comes from the line of Mariana Perez Mora with Bank of America. Please proceed with your question.
Mariana Perez Mora: Good morning, everyone. I have two questions. First one is more like big picture. How should we think about the organizational structure in terms of timing, how long, how much it’s going to cost, and how should we think about the cost structure and workforce once this is done?
Tom Bell: Yes, thanks, Mariana. So, first of all, we will operate in the current structure through the rest of this year. So, in fact, in all of my communications to the Leidos team, I’ve been hammering home, stay focused, stay focused on the current organizational structure. Our customers rely on us, and I’m relying on the team to deliver on our promises this year to our customer. The new organizational structure that I articulated will take place on January 1st. And frankly, it is not a reorganization. It’s simply a realignment of the existing Leidos business in a post-pandemic fresh look at the organization for efficiency and effectiveness, and that’s really the main goal. How do we increase repeatability, increase our prowess going to the markets?
How do we satisfy customers with better products across customers where they tended to be siloed in the last organizational construct we had? And so, it’s my expectation that the new organization is going to unlock all sorts of revenue and profit opportunities. In that regard, one of the first things I’ll be doing in the new year is challenging the new executive leadership team to create full potential growth plans for each of the new five businesses. And in those full potential growth plans, we’ll be looking at the marketplace, the competition, the whole suite of technologies and capabilities we need to compete and win effectively. And I expect that we’ll see growth plans for each business that are unlocking growth that is currently squelched or squandered in the current environment.
So, I’m very hopeful about it. In terms of costs, Chris.
Chris Cage: Less is better, but listen, that’s not the primary motivation to do this, as Tom talked about. I do see each of these businesses having different objectives as it relates to that. In the example of Defense systems, hey, we have been investing and we will continue to invest more in engineering and technical depth. That is not a cost-driven exercise to get those businesses aligned effectively. But in the case of digital modernization, these repeatable solutions, this automation, obviously, those can lead to more efficient delivery structures, back-office structures, those types of things. So, we’re very excited to get to the full potential, and we’ll have a lot more to share on that, Mariana, as we get to that next call at Q4.
Mariana Perez Mora: Thanks so much. And then my follow-up is more specific to healthcare. Incentive fee performance on the medical examination was strong once again. Could you please measure that for the quarter and give us a sense of how are your expectations for that too, like in the near term to come down or not?
Chris Cage: Yes, Mariana, absolutely. This is an area where the customer’s always had both incentives and disincentives associated with these contracts. And earlier this year, as the PACT Act volume was ramping up, they modified some of those. And the team has been doing an excellent job not only on throughput, volume, but customer satisfaction, timeliness, et cetera. The customer is motivated to raise the bar yet again because they want to make sure we’re continuing to deliver against a high volume of demand. So, we’ll continue to recalibrate on what that full potential looks like. But I would just say that we’re excited about the prospect of those incentives continuing to contribute, not only in the fourth quarter, but as we look ahead in 2024.
Tom Bell: Yes, and just if you don’t mind, Mariana, me piling on, so proud of the team. And frankly, as a taxpayer, proud of the customer. The customer should be challenging us to raise our standards and raise expectations each contract. And so, they did. We performed. We – through strikes – they changed the strike zone and tightened it up a little bit. And so, I have every expectation that the team can throw strikes even better in 2024 than they did in 2023.
Mariana Perez Mora: Thanks so much.
Operator: Our next question comes from the line of Cai von Rumohr with TD Cowen. Please proceed with your question.
Cai von Rumohr: Yes, terrific. Thank you very much. Great results, guys. To maybe follow up on Mariana’s question, so if we take out the $14 million COVID, which was kind of prior period, you did $18.6 million, which is terrific in Health. Could you quantify how big were the incentive accords in that quarter? And give us some sense if they’ve tightened it up. I mean, are they going to tighten it so those margins go down? Because I think at one point, you were hoping to do mid-teens. It now looks like you’re doing $18.5 million, $18.6 million this quarter. So, where’s that likely to go? And what impact do you see from potential government shutdown, because you mentioned that as a potential issue going forward.
Chris Cage: Yes, Cai, let me get going here, and if Tom wants to add on, he can. Look, we’re not going to quantify the specifics around the incentives. I would just say that this year, if you look at 2023, we will not have a full year worth of those incentives in our results. So, the good news is, 2024, we expect that to be something that can contribute for a full year, but also we’ll have to step up our game relative to the customer increasing the standards because we all want to make sure the veterans are being well served, that our timeliness stays high, that the throughput stays high, and the quality stays high. So, it’s been a nice benefit. We have incentive fee structures across a variety of contracts, and our objective is to deliver exceptional service and try to maximize those.
These ones just happen to be more noteworthy. But big picture on Health, we had previously said a mid-teens was a good margin level for the business. Obviously, we think we can do better, and we are doing better than that now. And whether that’s in the 17%, 18% zone, we’ll endeavor to sustain that level of performance. On the shutdown, this is an imperfect science, but we’ve spent a lot of work because we got so close at the end of September. Big picture we think on the order of $100 million-ish of revenue, potential risk, $10 million to $15 million of OI risk that we’re managing through. I mean, the most important thing is we work hand in glove with our customers right up to the deadline, and that we work with our employees to make sure they understand what they’re to do if they’re unable to perform on the customer mission.
And hopefully, we’ll find an opportunity to get back to work quickly if it were to happen. But that’s kind of our current assessment, but it’s one that we will continuously refresh as we work through a write-up to a potential deadline.
Tom Bell: But again, just to foot-stomp at a little bit, Cai, as Chris mentioned in his comments, the risk of a full 45-day shutdown is included in the lower end of our guidance. So, consistent with promises made, promises kept, given the risk of a full 45-day shutdown is possible, the guidance incorporates that risk.
Chris Cage: I mean, the good news, Cai is, we have a lot of funded backlog. We have a lot of essential programs, and we’re well positioned to navigate these headwinds.
Cai von Rumohr: So, just to be clear, as a follow-up, the $100 million and the $10 million to $15 million in OI, that is for Health or that is across the company?
Chris Cage: No, no, no, across the company, Cai. As it relates to Health, that’s probably one of the least impacted areas. So, that’s across the company.
Tom Bell: Veterans is an essential service.
Chris Cage: That’s right.
Cai von Rumohr: Okay. Thank you very much.
Operator: Our next question comes from the line of Sheila Kahyaoglu with Jefferies. Please proceed with your question.
