Leidos Holdings Inc (LDOS) — Q2 2025 Earnings Call Transcript

Thank you, and good morning, everyone. Joining me on today's earnings conference call are CEO, Tom Bell; and CFO, Chris Cage. Today's call is being webcast on the Investor Relations portion of our website, where you can find the earnings press release and the presentation slides for today's call. As shown on Slide 2, our discussion today will contain forward-looking statements based on the environment as we currently see it and thus includes risks and uncertainties. Our press release contains more information on the specific risk factors that could cause actual results to differ materially from anticipated results. Turning to Slide 3. We'll also discuss both GAAP and non-GAAP financial measures, and today's press release and presentation slides contain a reconciliation between the two. And now let me turn the call over to Tom, who will begin on Slide 4.

Thank you, Stuart, and thank you all for joining us today. I'm pleased to speak to you all against the backdrop of our truly differentiated Q2 results. We've recorded robust revenue growth, 4.8% year-to-date, record profitability, 15.2% EBITDA margin this quarter, and robust operating cash flow, up 28% this quarter. These results are especially gratifying given the dynamic market environment through which we are navigating. Behind this performance is our proactive enactment of intelligent austerity measures, a team that is leaning into our unparalleled customer understanding and engaging customers as their partner to create smarter and more efficient outcomes. Our technology, AI, and all our golden bolts are being wrapped even more aggressively around our products and services to enhance our customers' effectiveness and completely align all of Leidos around our North Star 2030 strategy. It is because of this that I'm also pleased to be able to raise our full year guidance for 2025. As you will recall, our North Star 2030 strategy is comprised of five growth pillars: space and maritime, energy infrastructure, digital modernization and cyber, mission software, and managed health services. Our determined ongoing engagement with customers continues to validate these North Star 2030 growth pillars. In fact, the significant multiyear funds provided by the One Big Beautiful Bill speak directly to our North Star 2030 growth pillars and our core Leidos capabilities. With the One Big Beautiful Bill now law and the administration's priorities now clear, our customers are moving out to execute programs for essential missions right in our wheelhouse. These include our space and maritime growth pillar, supporting a wide range of needs in the Golden Dome initiative; our mission software growth pillar, along with our global air traffic control experience being tightly aligned to the FAA's ambition for a brand-new air traffic control system; the TSA embarking on an ambitious airport screening modernization effort, which is tightly aligned to our capabilities in our airport security business; the Department of Homeland Security receiving significant additional funding, validating our ongoing investments in our ports and border security business as well as our cutting-edge counter-drone capabilities and the drive for improved health outcomes and better service to our nation's veterans, speaking directly to our managed health services growth pillars. All in all, it's indeed a very exciting time for all of Leidos. Now I'd like to take a few minutes on this call to highlight the maritime component of our space and maritime growth pillar. Over the coming years, the U.S. Navy plans to rapidly deploy a larger integrated fleet of manned and unmanned vehicles, a direction that closely aligns with our strengths in maritime autonomy. This enhanced battle force will not only prepare the U.S. for future challenges, but also revitalize the U.S. shipbuilding industrial base. Leidos' full life cycle maritime capabilities are unmatched to meet this need. Leidos is the only company that possesses world-renowned naval architecture capabilities, proven experience fielding successful autonomous maritime vessels, demonstrated capabilities in state-of-the-art maritime autonomy AI, and experience in designing and integrating packaged mission payloads. So Leidos is in a pole position to support the expansion of the U.S. Navy with an autonomous maritime fleet. The fiscal 2025 reconciliation bill allocated robust funding for autonomous vessels along with related autonomy and battle management software. Let me highlight a few examples of the role Leidos is already playing in this area. First, the U.S. Navy has contracted Leidos to survey commercial ships for future potential conversion to high-performance mission-ready autonomous medium unmanned surface vessels. Second, the U.S. Marines have a desire to scale up production of Leidos' low-profile small unmanned surface vessel, Sea Specter, to support expeditionary warfare, particularly in the Indo-Pacific. U.S. Marines currently have three Sea Specters in operation and have praised its low-profile approach and capacity for missions in contested environments. And third, a classified customer has contracted with Leidos to procure one dozen Sea Darts, our low-cost attritable unmanned underwater vessel to augment their arsenals. The customer has expressed an intent to acquire an additional 70 Sea Darts next year with additional units to follow. This opportunity further positions Leidos as a leader within the subsea warfare domain critical to our nation's defense strategy. We have invested in maritime autonomy for decades. And as a result, our Leidos Autonomous Vessel Architecture, or LAVA, is the most trusted and reliable maritime autonomy on the market. LAVA has demonstrated its endurance, long-range capacity and precision while sailing more than 120,000 nautical miles. This includes our fleet of Leidos-built MUSVs that transited the Pacific from San Diego to Australia and back last year. This journey marked a huge advancement in maritime autonomy and reinforced our leadership in this crucial domain. And we are continuing to invest in technology to improve the performance and interoperability of our nation's maritime capabilities. Our team is adding our proven battle management software, AlphaMosaic, originally developed to optimize battlefield and airspace strategies, to our maritime command and control capabilities. Simultaneously, our NATO allies are increasingly acknowledging their escalating maritime threats and therefore, the imperative to modernize and prepare their maritime forces. This collective global focus presents a nearly $4 billion pipeline for Leidos over the coming years. Across all these opportunities, the new administration's playbook is clear, leveraging technology and AI to disrupt old models, drive out costs and deliver more efficient solutions. We share that passion and are thrilled to have a receptive customer eager for technology adoption. For some time, Leidos has been deploying trusted mission AI to our own business to lead our own positive disruption. We've been putting AI to work for us for years. And the results are extremely encouraging. Our AI work is on track to save more than half a million labor hours by the end of this fiscal year, and we're just getting started. Let me give you a few examples of this work in action. In our growth office, we're using generative AI to help write better proposals faster. In this regard, we've already achieved about 20% greater efficiency on tasks common to every large proposal. In finance, we're using advanced automation to expedite our cash flow process and as a result, have decreased invoice build and delivery time for select customers by almost 40% while driving down error rates. And we've enabled over 1,000 software developers with AI-powered coding tools. For these coders, we've seen more than a 30% reduction in the time it takes for them to deliver ready-to-test code. And using the same Leidos AI tools deployed at the FAA, we've seen a 60% increase in development productivity. This brings me to my final point today. The government is now transitioning from policy to productivity. This administration came in with a clear objective to drive efficiencies and attack the status quo. And as discussed on our last call, that's fertile ground for Leidos and core to our business model. Now I'm pleased to report that we continue to have success positioning Leidos as part of the solution, not the problem, as this administration moves quickly to make government outcomes smarter and more efficient. And it's apparent to me through the myriad of cabinet level engagements I've had to date that this administration is seeking to work with agile forward-leading solution providers like Leidos. Our customer decision environment is also improving. Our 0.9 book-to-bill ratio in the second quarter was a strong snapback from Q1, and more than half of these awards were for new and takeaway business. Late in the second quarter, we were notified that we were also awarded another multibillion-dollar takeaway within the intelligence community. But as happens, that contract wasn't definitized for several weeks. Had the contract been finalized in June instead of July, our Q2 book-to-bill ratio would have been 1.3, and our backlog would have increased 4%. Looking ahead, our pipeline of opportunities remains robust, and we expect much greater awards pace in the back half of this year. It also bears mentioning today that I am encouraged by the first fruits of our Kudu acquisition. As a result of fast integration of Kudu into our business, we've already added $400 million in pipeline opportunities that neither company was pursuing separately. And we are convinced that with the combined Leidos Kudu capabilities, we've now driven up the probability of winning on another $2 billion of near-term submits. Given our improving market backdrop, we're confident in our ability to deploy capital to activate our strategy and benefit our shareholders. As we execute our North Star 2030 strategy, we will continue to be on the lookout for constructive acquisitions that support our growth pillars and offer a compelling return on capital. And at the same time, our confidence in future cash flows enables us to remain multifaceted in our capital deployment philosophy. So consistent with earlier indications, we will undertake additional share repurchases and debt paydown during the back half of this year. So in summary, we are fully executing our North Star 2030 strategy. We're seen as part of the solution in the drive for smarter and more efficient government outcomes. And our customers have the funding and the conviction to move forward boldly in areas that speak to Leidos' core capabilities. With that, before we take your questions, I'll turn the call over to Chris to run through our financial details of the quarter and our improved 2025 outlook. Chris?

Thank you, Tom, and welcome to everyone joining the call this morning. With the first half of 2025 completed, we have demonstrated what our unique and diverse portfolio can achieve. During this time, each segment saw margin growth and delivered mid- to high single-digit growth. We believe that even greater achievements lie ahead for Leidos. From a high-level perspective, the second quarter indicates Leidos performing as expected, consistently surpassing forecasts to yield strong earnings and cash flow growth. However, this quarter was far from typical. In our May call, we estimated that the revenue impact from administrative efficiency measures in 2025 would be around 1%. This assessment still holds and is expected to be evenly distributed across the second, third, and fourth quarters. Our growth narrative faced challenges due to significant constraints in the procurement process during the early months of the new administration. We have navigated these challenges by focusing intently on delivering on the administration's innovation and efficiency goals. For instance, many clients are now aiming to reduce IT costs as part of their efficiency initiatives. After initially concentrating on canceling contracts and scaling back, there has been a shift towards consolidating contracts to increase accountability and lower overall government costs. We have mitigated a large part of our DOGE challenges by leveraging our scale, diverse capabilities, and outstanding contract portfolio to help clients develop new requirements onto our existing contracts where we have broad scope and ceilings. With that context, let’s examine this quarter's performance, starting with the income statement. Revenues for the second quarter reached $4.25 billion, which is a 3% increase year-over-year and a sequential increase despite delays in awards and ongoing contract evaluations. Profitability showcased the team's urgency and discipline. Adjusted EBITDA was $647 million for the quarter, a 16% year-over-year increase, and adjusted EBITDA margin rose by 170 basis points to 15.2%. Non-GAAP diluted EPS grew by 22% to $3.21, surpassing last quarter's record of $2.97. Our EBITDA margin this quarter was our highest ever, exceeding the previous quarter by 100 basis points. Let me elaborate on how we achieved this level of profitability and what might be sustainable moving forward. The primary contributors were our contract portfolio, strong execution, and efficient operations, which we expect to maintain for the foreseeable future. The second quarter included an $8 million benefit from EAC adjustments, which was actually $3 million to $4 million lower than our average quarterly performance. As Tom mentioned, we are heavily focused on using AI and automation to reduce indirect expenses and enhance profitability and competitiveness. However, we did experience some favorable one-time items that bolstered earnings this quarter, notably a $25 million insurance reimbursement for legal expenses and an $8 million tax refund from previous state tax filings. Importantly, in the first two quarters of 2025, we took proactive steps to manage spending across the company, which was crucial during these unprecedented times. Given the uncertainty surrounding the new administration and various executive orders, we exercised tight control over our indirect expenses. Now that the customer landscape is beginning to stabilize and procurement is accelerating, we anticipate returning to a more normal spending level while aggressively investing to gain market share. Moving on to the segment drivers, it's clear that each of our segments played a part in our strong results. National Security and digital revenues increased by 3% year-over-year. Several contract awards from the latter half of 2024 are now ramping up, and we’re seeing additional tasking on significant franchise programs like DES. Building on the award momentum, this segment was the main bookings driver in the quarter, and we expect growth to continue despite ongoing DOGE challenges for some digital modernization initiatives. Non-GAAP operating income margin was 10.4%, unchanged from last year’s quarter. With Kudu's acquisition closing in late May, the contribution to our top and bottom lines was minimal as anticipated. The team has done an excellent job with the integration so far, and we’re excited about the potential this acquisition brings. Health and Civil revenues increased by 1% year-over-year, with a non-GAAP operating income margin of 24.9%. Sustaining high performance levels was due to a consistent high volume of medical disability exams and our team's unwavering focus on delivering excellent innovation. In Commercial International, revenue grew by 1% year-over-year, driven by ongoing demand in SES, steady performance in our commercial energy segment, and improved execution and growth within our U.K. business. Top-line growth was moderated by last year's hardware refresh in our Australian IT line of business. Non-GAAP operating income margins stood at 8.5%, an increase of 780 basis points year-over-year, resulting from the anniversary of prior year write-downs on U.K. programs and a more favorable product mix within SES. Lastly, Defense Systems revenue witnessed the highest growth at 10% year-over-year, fueled by increased volumes on SDA Wide Field of View Tranche 2 and integrated air defense programs like IFPC Increment 2 and the Electronic Warfare Mission Support program mentioned in the earnings press release. Non-GAAP operating margins of 9.8% were down from Q2 of 2024 but improved sequentially. We are on track toward achieving sustainable double-digit margins in our Defense Systems business. Looking ahead, we are confident in our unique capabilities to support key priorities such as Golden Dome and Maritime. Regarding cash flow and the balance sheet, we generated $486 million in cash flows from operating activities and $457 million in free cash flow, resulting in a free cash flow conversion of 110%. During the quarter, we carried out two major capital deployment activities. First, we completed the acquisition of Kudu Dynamics for a preliminary purchase amount of $291 million, net of $29 million in cash acquired. Second, we executed a $500 million accelerated share repurchase on May 20, retiring over 3.6 million shares at an average price of $138.44. These moves exemplify our strategy to use our balance sheet to enhance shareholder value. By allocating approximately half of our operating cash flow for the year to strengthen our position in a rapidly growing market and repurchase shares at attractive prices, we are well-positioned for the future. We finished the quarter with $5.1 billion in debt, reflecting a gross leverage ratio of 2.2x, and $930 million in cash and cash equivalents. The robustness of our balance sheet provides significant room for further capital deployment aligned with the strategic priorities Tom outlined. We will continue to assess the market and properly balance debt repayment, capability-driven acquisitions, and additional share repurchases. Finally, regarding our outlook, the customer environment in the first half of the year has been somewhat unstable. While some disruptions may persist, as Tom pointed out, awards are increasing and the administration is clearly moving forward. We now have enhanced clarity and confidence about both the near- and long-term future for Leidos. Therefore, we are pleased to raise and narrow our guidance for the year across all metrics. For revenue, we are raising the lower end of our range by $100 million and the midpoint by $25 million, setting a new range of $17 billion to $17.25 billion. Although Tom and I are optimistic about the trajectory of funding and ongoing contract evaluations, we have seen some revenue declines, and we think it’s prudent to anticipate potential customer delays and other uncertainties. Our performance thus far gives us strong confidence in our ability to deliver on margins and earnings. We are increasing our adjusted EBITDA margin guidance from the mid- to high 12s range to the mid-13s. Consequently, we expect non-GAAP diluted EPS to be between $11.15 and $11.45, narrowing the range by $0.10 and elevating the midpoint by $0.75. These ranges reflect a return to more normal indirect spending and an increase in investments we plan to make for the remainder of the year to foster future growth and leverage the administration's priorities funded by the One Big Beautiful Bill. Finally, we are raising our operating cash flow guidance by $200 million, from $1.45 billion to $1.65 billion. This increase accounts for roughly $50 million due to enhanced EBITDA performance and $150 million from tax changes in the One Big Beautiful Bill that allow us to immediately deduct some previously capitalized R&D costs. Overall, the team has once again demonstrated its determination and adaptability during these rapidly changing and demanding times. We remain confident in our outlook for 2025 and beyond as we execute our North Star 2030 strategy. With that, operator, we are ready to take questions.

I was hoping if you could speak to the potential financial impact on the company if the new GSA initiative to purchase commercial software and services directly from vendors rather than integrators. Maybe talk about it from a pass-through perspective, which sometimes occurs or when it's embedded in contracts, that would be helpful.

Sure, Tobey. Thanks, Tom here. I'll start and then hand it over to Chris for additional details. We see the GSA taking a bigger role in government procurement as a positive for the market and the industry. They are a professional procurement organization that tends to meet their schedules and achieve consistent outcomes, which is beneficial for us. They also prefer commercial behavior, aligning with our strengths. We value outcome-based commercial contracts and are excited to engage with this administration to increase our visibility at Leidos. Overall, we believe we align well with what the GSA is seeking and see a good opportunity for business growth as a result. Specifically regarding hardware and software, Chris can provide more details. We are not a value-add reseller or consultant; we don't profit from simply passing hardware and software through contracts. Our strength lies in mission systems, and anything that enables us to procure hardware and software more efficiently allows for more budget allocation toward mission systems, which highlights our value. We are enthusiastic about this trend, closely monitoring it, and maintaining strong communication with the GSA, feeling optimistic about our prospects in this environment. Chris?

Thank you, Tom. I want to emphasize that we meet our customers where they are. We are prepared to support them depending on how they choose to procure goods. However, as Tom mentioned, our focus is not on the costs of procuring hardware or software. Typically, these costs amount to several hundred million dollars on average that get passed on to customers, sometimes as part of a bundled solution, and I expect that to remain unchanged. Customers are primarily interested in achieving specific mission outcomes. When we do purchase hardware or software, the costs are typically passed through on a cost-plus or time and materials basis, which results in very low, and sometimes even zero, margins. Therefore, this aspect does not significantly contribute to Leidos' value or our earnings and cash flow. We are flexible in our approach as the situation evolves, and we remain ready to support our customers. As Tom noted, more reliable procurement processes benefit everyone, and that is the direction GSA is heading.

Appreciate all the comments on the Big Beautiful Bill and the great exposure you have to these areas. Just love to hear a little bit on how you think about with these demand signals being so strong, the opportunities for you to invest organically in the business, in particular, in maritime. You guys have been really efficient in building a great business on a capital-light model. But just broadly, where are the opportunities today to invest organically?

Yes, thanks, Jonathan. Yes, we're very excited about all the opportunities in the Big Beautiful Bill. And like I said in my prepared remarks, all the priorities of this administration speak to our growth pillars and core Leidos competencies and capabilities. So we're very excited about it. From FAA air traffic control modernization, a huge opportunity for Leidos going forward. TSA screening modernization, a huge opportunity for Leidos going forward, especially if you bundle both of those and think about the airport of the future, we're very excited about the receptivity of this administration to big ideas like that, the airport of the future and taking air travel to a whole new level of customer experience. Border security, obviously, is a huge area of focus for this administration and a huge funded area in the Big Beautiful Bill. And Golden Dome is a big area that our defense systems is very plugged into with General Guetlein coming on board and ramping up that whole program and the shape and structure of how that's going to defend our homeland in the future. So we're very excited about the whole range of opportunities that the Big Beautiful Bill gives us. Specifically on Maritime, thank you for asking about it. We're exceptionally excited about that because we started talking to the INDOPACOM command over a year ago about the demands of that command in the Indo-Pacific and the requirement for unmanned autonomous vehicles. So we've been, frankly, investing in and driving prototypes of unmanned vessels. We actually have deployed our LAVA autonomous vehicle architecture on over 10 vehicles that are in the water. And we have a program that we're bringing forward to the Navy that we think combines the need for a quick build of very agile maritime autonomous vessels with the rebuilding of the maritime industrial base in the United States. That doesn't mean to the specific question you asked that we're going to get into the shipbuilding business or the shipyard business. We think there are ample shipyards in America that can satisfy the need for these medium and small USVs. That's the network we're tapping into to enable them to be a part of the solution around the whole of the nation as opposed to us buying and/or building shipyards. I hope that helps with the context. Chris, anything to add?

Yes, I’d like to highlight a couple of points beyond maritime. First, as Tom mentioned, being demonstration ready and pilot ready is crucial in this environment where stakeholders are eager to see tangible results. Given our guidance for the rest of the year and our outlook for the second half, one of the reasons our earnings aren't at an elevated level is that we are identifying a wealth of investment opportunities to position ourselves effectively. We are very excited about this. Additionally, Tom and I recently visited our upgraded Huntsville campus, and I must say, it’s impressive. The team has implemented several enhancements to boost throughput and capacity across multiple product lines, many of which will accelerate as part of our One Big Beautiful Bill initiative, all while maintaining a capital-efficient approach. I believe we are in a strong position.

I wanted to follow up talking a little bit about the opportunities in the reconciliation bill. And I wonder if you could maybe rightsize us on the scanning business and how you view the opportunities there, maybe the size of the business now. And then when you think about the nonintrusive border equipment, the TSA and airport equipment, how you think about the scale of opportunities, kind of your ability to capture them in the competitive environment and the time frame for capturing them?

Yes, thanks, Seth. And across the spectrum of the Big Beautiful Bill, like I was just speaking, we see ample opportunities. Let me run down a few numbers for you. In the billions of near-term addressable funding that we've identified, core to Leidos' capabilities, $1 billion to $2 billion in the FAA modernization supplemented by annual appropriations going forward; $2 billion to $3 billion in autonomous shipbuilding, as I was just speaking with Jonathan. There's $2 billion to $3 billion we estimate in nonintrusive inspection and border surveillance equipment, so a very big market there; $4 billion to $5 billion in counter UAS capabilities, ground-based radars, low-cost missiles, hypersonics and other things that will play back into the Golden Dome. And don't forget about the capacity for a large rural health transformation push through the VA that speaks right back to our wheelhouse of how we've positioned our health and civil business to serve our nation's veterans and meet them where they are. So we're very excited about the range of opportunities that the reconciliation bill gives us. And specific to your question, when it comes to border security, obviously, it was one of this administration's biggest thrusts coming into office. We've had multiple engagements with the Department of Homeland Security. We feel as if we have a very receptive audience in the Department of Homeland Security around our capabilities that are ready to field now. As Chris was saying before, they're not interested in PowerPoints and promises. They're interested in seeing capabilities demonstrated and products that are in production. We have those products for surveillance and for counter UAS and for ensuring safe venues in 2026 and beyond. And so the Department of Homeland Security, Customs and Border Patrol, these are people we're very actively speaking to right now and are very receptive to what Leidos has to offer. Chris, anything you'd like to add?

The only thing I'd just to answer one part of your question there, Seth. I mean that's on the order of a $600 million business for us. I mean it's an integrated SES business with ports and borders and aviation equipment. But as you know, the ports and borders piece goes back decades. That's our heritage, and we've been serving CBP, TSA, and other customers for a long, long time and look to continue to expand our offerings to those customers here going forward.

Great quarter, good performance. I wanted to ask a specific question maybe on health. How do we think about just health growth going forward, whether it's the rural health program, Tom, you just mentioned a minute ago. Maybe give us an update on DHMSM and VBA. And how do we think about the contribution from incentive fees in the quarter and how we should be thinking about it going forward?

Yes, thanks, Sheila, and thanks for joining the call this morning. Let's see. On Health and Civil, we've seen record volumes of about 5,000 cases per day in June. So there's a huge volume going through that business. And we're earning more than our 25% share of a four-way provider down there. So we're very excited about the volume of business we're doing through our Health and Civil business and our ability to serve our nation's customers. As you know, the better you do, the more referrals you get, the more capacity you have, the more referrals you get. And so this is where, based on our performance, we're excelling. The team is laser-focused on driving our performance to be best-in-class. And as we've talked about in the past, we're investing in technology, both in the brick-and-mortar clinics that we operate and the software that creates a very cohesive scheduling dance between the patient, the clinician, and the clinic itself, and also our deployment of technology for the rural exams. As you ask, the rural exams are an area where we think we are leading the pack in the deployment of our mobile clinics where, again, through sophisticated scheduling software, we're able to deploy those units to meet veterans where they are so that we serve them in ways that satisfy them. So we think this business is going well. The VA Secretary has said he wants to reduce backlog by 60,000 by the end of the year. So that would be 125 claims a day. So we think there's a tremendous amount of work through this year and well into next year as we seek to differentiate ourselves to continue to serve our veterans in that way. Chris, anything from you?

Sheila, I would just hit on a couple of other points, too. The team has done great work on DHMSM, as you know. And after the second quarter, we were successful in securing that extension that we had previewed previously for another year, and that just speaks to the strong performance that we've delivered for that customer. And now, as you're probably aware, they've come out and asked about or put out an RFI to talk about how to consolidate the DoD and VA EHR record systems. So that's out there. And obviously, our teams are looking to ensure that we position ourselves to support those efforts going forward. And then looking ahead to the pipeline, there's still plenty of things that we're positioning for with the Navy fleet and family support, global objectives. There are several procurements on the horizon that are already kind of in our pipeline capture teams and looking to how we grow that business going forward. But opportunity-rich environment, again, great funding that we see on the rural and behavioral side, sending a strong demand signal, and we've proven to be somebody that the customer can count on to deliver successfully with high performance.

This is Joshua Korn on for David. I wanted to follow up on, I think it was Seth's question. You mentioned border security and the procurement funding for unmanned Marine and UAS. But I wanted to ask specifically about the funding in the reconciliation for O&M. Do you have any benefit from the additions to those funds?

From O&M funding, I'd say that again, as that all sorts itself out, there's certainly ongoing programs and efforts that we benefit from O&M funding. And so that supports the deployed fleet of equipment that we've already put in place and upgrades and enhancements of those particular units as it relates to software, expanded sustainment efforts. It's unclear yet whether any of those funds will be able to be redirected to buying incremental equipment on the O&M side as it relates to the CBP and ports and borders, if that's where you're asking that. But very pleased about all of the opportunities around the reconciliation bill. And our teams have dissected that. And as Tom gave you a good walk down, we see a rich environment across many parts of our portfolio.

Tom, could you comment on the recent significant multibillion-dollar award to a competitor who is consolidating IT contracts at the Department of Defense and around AI? Do you think this might affect your business, or is it not a concern? I'm interested in your thoughts on the changing competitive landscape, which you've noted is quite dynamic.

Yes. Thanks, Peter. Yes, sure. We read the news, too, and that's an eye-watering number, $10 billion IDIQ. And that's very impressive. But as you all know, that's where the game begins, not where it ends. It's no surprise to us that this administration is very interested in commercial technology and outcome-based. And so we don't see that net-net as a huge new competition for us, but rather an opportunity for us to also be that commercial disruptor we've always been. As we've talked about in past calls, Leidos' core is making government outcomes smarter and more efficient. That's still our core today. We're disrupting ourselves. We don't feel like anybody knows how to deploy AI or AI tools better and more effectively than we do. And so we're looking forward to continuing to use AI in our products and solutions for our customers' benefits in ways that are trusted by our customers. You'll recall that in past calls, we've featured on trusted mission AI. And we still think that, that is a key calling card for Leidos that we continue to lean on. The ability for our customers to trust the AI they are deploying in their products and in their solutions and in their systems is key. And we continue to get great receptivity in our customers to the conversations we have about using all the commercial tools available in a way that also allows them to trust the outcomes that the products are giving them. So yes, eye-watering number, good on them, but that doesn't frighten me away from the market.

My question is going to be about Dynetics. You received a $265 million award this last month for indirect fire protection capabilities and a couple of other awards. This business was growing slower than expected back then when you bought it. Could you please like tell us like how is that going? What type of margins you are generating? And how do you think about growth ahead, especially as Golden Dome shapes up?

Sure. Thank you, Mariana. And yes, the Dynetics acquisition was a very intelligent acquisition back in the day. Perhaps it took a little longer than we might have hoped to fully integrate it and get it running. But as Chris kind of mentioned in his comments, we feel like now we've got a leadership team there that is very focused on results, and it's matching the moment of Golden Dome and all the needs for counter UAS capability and surveillance that Dynetics has invested in for years. And so maybe a little less robust and uptake after the acquisition, but now some four, five years later, it is really firing on all cylinders. And as you allude to, earning IDIQs, earning production awards, the IFPC program, a real key to the defense of Guam and Homeland Defense going forward. Golden Dome, the connectivity right there. And at the space layer, when you think about Golden Dome, the whole tranche 2 of our satellite programs is really right in the wheelhouse of constant surveillance. So I feel really good about the Dynetics acquisition and us bringing it to fruition. Just like Kudu and other acquisitions we've done in the past, they're very much part of the portfolio to meet the moment of a diversified Leidos, which is match fit to help our customers going forward. Chris, anything to add?

Well, I mean, thanks for the question, Mariana. I appreciate you noticing. I mean, as Tom mentioned, it's been a journey, but they have made tremendous progress, second-best quarter of organic growth since we reorganized them. We've seen double-digit margins in certain quarters, and we're certainly on a path to get there and exceed that on a sustainable basis. Yes, IFPC Increment 2 is a program that's accelerating. But beyond that, we see runway to scaling up our hypersonics capabilities under the common hypersonic glide body TPS contract. That's moving forward, and there'll be more funding there. Other programs of record, including AirShield and progress on our small cruise missile initiative with Black Arrow. So exciting times ahead, a number of capabilities that are maturing and a leadership team there that's just really knocking it out of the park.

And if I may, I want to do a follow-up on the DHS CBP opportunities that you mentioned related to the One Big Beautiful Bill. You talked about ports and borders and counter UAS. But how should we think about the SES exposure to nonintrusive machines as well as CBP also builds up that capability?

Yes, we are referring to that, Mariana. The VACIS equipment for border crossings is definitely part of what the team plans to implement in response to that demand, along with other capabilities like air defense and situational awareness for radar systems, as Tom mentioned. The core nonintrusive inspection offering is already in place at the southern and northern borders. There are opportunities to expand that presence going forward, and the team aims to capture a significant share as those contracts are awarded in the fall.

Good old elbow grease and great management. I got to give credit to the team that's been in there for the last 12 to 18 months and really have improved our global service footprint, solidified our supply chain issues. Yes, ports and borders is an area that we think is an attractive market. So as that scales up, that certainly bodes well for the future of that business accelerating profitability as well.

Last call, I think the comment that the team provided suggested continued growth and margin expansion over a multiyear period. Maybe refreshing that view, how does the company think about growth acceleration from, call it, the kind of underlying guide midpoint of 4% growth ex efficiency headaches? And then maybe focusing on the civil portion of that specifically, like how does the team accelerate Civil growth? And then in terms of the margin expansion comment that you provided last quarter, is it still fair to assume margin expansion from the updated guidance midpoint this year?

Thank you, Colin. Let me start with a little bit on the environment and the booking environment that we're seeing. As I said in my prepared remarks, we had a strong snapback from a low book-to-bill ratio Q1 to a strong Q2. That gives us a trailing 12-month book-to-bill of 1.3. So nothing to be ashamed of there and a very, very exciting pipeline. We see that our pipeline over the next 12 months is some $70 billion of opportunities, and that's up $3 billion year-on-year. And also important in that statistic is about three-quarters of that is takeaway work, not recompete for work we already have, but new work for the future. So we see the administration moving on to get after spending the money that has now been committed as a part of the multiyear funding and the reconciliation bill and the fiscal '26 budget. And so we expect a strong order intake over the next two quarters. In specific, there's a little bit of a lag from a profitability standpoint. But over to you, Chris.

Yes, Colin, that was a multipart detailed question. So let me attempt to address those points. Yes, when we sat here last quarter, we didn't envision raising our full year margin guidance to mid-13s. Very pleased to be able to do that. The team has done a great job. Not ready yet today to say onwards and upwards from there, but we're very pleased with that performance. And I think you can see what we're capable of with what we just delivered in Q2. So the business has a lot of gas in the tank. And as we alluded to, Defense Systems isn't where we see it going to in the end game. Commercial International improved substantially, but there's more room to move up there. So there's still ample levers and parts of the portfolio to drive margin improvement. But sustaining the mid-13s becomes our objective here that we'll focus on moving forward. And as it relates to growth, I mean, Tom just talked about the opportunity-rich environment in the health and civil space, specifically, managed health services is our core growth pillar, but the opportunities in the FAA are part of that growth story as well. So we'll give you a lot more color on '26 as we get into the fall and next earnings call, but you can see the momentum is building.

Just following up on the bookings question. It seems like total book-to-bill is pretty healthy here, funded, maybe has been trending a little lighter. Any dynamics to call out there and a little bit more on what you're expecting into government fiscal year-end, which is typically pretty strong.

Yes, thank you for that, Gavin. First of all, I'm pleased to report that our year-over-year backlog has increased by $5 billion, which is a positive development. Tom mentioned the growing momentum, especially with the significant award we received just after the second quarter. This gives us a nice advantage heading into the third quarter. I also noted that we are solidifying our follow-on extension for our MHS Genesis work, which contributes to this momentum. Our pipeline is strong, and we anticipate growth in funding dynamics, although there have been some procurement delays and a shift towards more incremental funding in certain customer settings. However, this hasn't hindered our progress. We expect conditions to improve, allowing us to advance priority programs. Obligations can fluctuate, but we recently secured a modification in our VBA business that will provide funding in the third quarter as well. Overall, I view this as a reflection of the current environment, where we've experienced some slowdown and necessary pauses for reviews, but I believe the backlog will accelerate as we move ahead.

Yes. I would just foot-stomp that last part of what Chris said. It's no surprise. We've been talking about it for the first six months that there was a certain constraint of outflow of cash from this administration during the last six months. But now all that is breaking free. So as we think about our funded backlog, it's not a concern for Chris and I. We have line of sight to where the funding is coming from. We think we have good unparalleled customer understanding, working with those customers, and we feel very confident that the money is going to flow to the contracts that represent the great needs that our customers have for our products and services. So not a concern issue for me right now as I sit here in August of 2025.

I am curious about the overall situation. It seems that the strong engagement from DOGE with the industry is starting to decrease. Would you say that's accurate? Are we not observing any ongoing strong actions or assertive measures from the new government towards the industry? Additionally, could you confirm if the medical exam fourth supplier has now fully staffed all four regions, instead of just three?

Yes, of course. Thank you. I'll address both points and then pass it over to Chris. First, we have been closely monitoring all disruptions related to DOGE and DOGE-related contracts over the past six months. This includes stop work orders, terminations, descopes, and what we refer to as DOGE-inspired pricing reviews. Over the last six months, while we saw a notable increase in these disruptions during the first half, the past three months have been relatively stable, with no significant increases. It’s important to note that these are gross disruptions, not net disruptions. As Chris mentioned, the team has excelled in transforming these challenges into opportunities by collaborating with customers to ensure we continue to deliver essential products and services. I wouldn’t say we're finished; cost efficiency remains a priority for this administration, and cabinet-level secretaries are motivated to save money and achieve better results. Ultimately, Leidos' main focus is on enhancing government outcomes to be smarter and more efficient. We are shifting from a reactive approach to engaging in meaningful discussions about how to improve efficiency and effectiveness, which aligns perfectly with Leidos’ capabilities. Regarding the fourth vendor, we believe our share loss attributed to them is currently less than 1% of our volume. While I can’t speak to their business developments, we haven’t seen any adverse effects on our top or bottom lines from this situation. Chris, do you have anything to add to that?

I think you nailed it, Tom.

Michelle, it looks like we're coming up right on top of the hour. So I think we have time for one more question.

Chris, I’d like to follow up on your earlier comment. It seems you adopted a quite aggressive or disciplined stance regarding costs in the first half of the year. As conditions are normalizing, it appears you are easing up a bit to ensure you can capitalize on available opportunities. Could you provide some insights into how we should view the cost dynamics between the first and second halves of the year and what that might mean for our margin outlook in the second half?

Well, I'm probably not going to get that specific for you, Ken, but I would tell you, you're absolutely right. I mean as soon as we saw the environment has shifted, we laid out a plan with Tom, myself, and some members of our team of where we could dial back to preserve, obviously, the core operations of the company, invest in our people where appropriate, but to be fiscally conservative. And that added up to a substantial amount of savings that we had line of sight on for the year. We've delivered on four or five months of that savings profile to date. And now we see that it's time to go back to more normal operations for most of that given where we are in the environment and the opportunities that are coming forward. It's tens of millions of dollars of incremental investment, absolutely that we're planning to outlay here in the second half. And the idea is to keep flooding our depth, quite honestly. So we'll be smart and prudent around that, but we obviously want to turbocharge our AI adoption. Again, those demo-ready capabilities in maritime in the defense system space and with software. Those are our priorities, investing in our Golden Bolts. But I think it was just the right thing to do given the uncertainty on the horizon. And again, it kind of also speaks to our ability to flex our business model when needed. And we'll look to maintain some of those savings on certain areas that we didn't miss a beat on here going forward. So really excited about how the team responded to those dynamics.

Yes. And just to foot-stomp that last point, really kudos to the team for how they reacted to the austerity measures we put in place earlier this year. There wasn't a peak of complaint about it. Everybody got it. In fact, I think there was a positive cultural within Leidos that everybody understood this was a serious issue we were dealing with to face into this environment and make sure Leidos was seen as part of the solution, not the problem. So really was positive. We'll now dial back those austerity measures, but as Chris says, we're not going to take our foot totally off the brake. We're just going to release a little pressure.

I want to thank you, Michelle. I appreciate your help on this morning's call and obviously thank all of those who are able to join us this morning for your interest in Leidos. We look forward to updating you again soon. Have a great day.