Q2 2025 Earnings Call Transcript

Greetings. Welcome to Leidos' Second Quarter 2025 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker, Stuart Davis from Investor Relations. Stuart, you may now begin.

Thank you, and good morning, everyone. Joining me on today's earnings conference call our 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 2. 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 wrapping technology, AI and all our golden bolts even more aggressively around all our products and services to enhance our customers' effectiveness and completely aligning 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 5 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 3 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, software 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 0.5 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 some 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 an over 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 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 in the books, we've shown what our differentiated and diversified portfolio can achieve. Over that period, each segment expanded margins and delivered mid- to high single-digit growth. And we think the best is still yet to come for Leidos.

From the 30,000-foot view, the second quarter looks like Leidos just being Leidos, another quarter of beating expectations to deliver top-tier earnings and cash flow growth. But this quarter was anything but business as usual. On the May call, we estimated the 2025 revenue impact from administration efficiency actions to be about 1%. That remains true today, and that impact is spread roughly evenly across the second, third and fourth quarters.

Complicating our growth story, the procurement process was severely constrained in the first several months of the new administration. We've been able to overcome those obstacles by obsessively delivering on the administration's innovation and efficiency agenda. For example, many customers are looking to drive down IT costs as part of their efficiency imperative. After initially focusing on canceling contracts and reducing scope, we've now seen a pivot to consolidating contracts to increase accountability and lower the all-in cost of the government.

We've offset a large part of our DOGE headwinds by using our scale, breadth of capabilities and unmatched contract portfolio to aid our customers in developing new requirements onto our existing contracts where we have expansive scope and ceiling. With that as a backdrop, let's take a closer look at this quarter's performance, starting with the income statement on Slide 5. Revenues for the second quarter were $4.25 billion, up 3% year-over-year and up sequentially despite the headwinds from award delays and ongoing contract reviews. Profitability was where the urgency and discipline of the team shown brightest.

Adjusted EBITDA was $647 million for the quarter, up 16% year-over-year, and adjusted EBITDA margin increased 170 basis points to 15.2%. Non-GAAP diluted EPS grew 22% to $3.21, well surpassing last quarter's record high of $2.97. Our EBITDA margin in the quarter was our best ever by 100 basis points. Let me unpack that a little to give you some more insight into how we accomplished that level of profitability and what is likely to be sustainable going forward. The core drivers were our contract portfolio, solid execution and efficient operations, which we should maintain for the foreseeable future.

The second quarter included an $8 million benefit from EAC adjustments, which is actually $3 million to $4 million less than our average quarterly performance. And as Tom described, we're heavily focused on leveraging the power of AI and automation to drive down indirect expenses to improve profitability and competitiveness. However, we did have some favorable onetime items that lifted earnings in the quarter. Most notably, we received a $25 million insurance reimbursement for legal costs and an $8 million tax refund from prior year state tax filings.

Equally important, for the first 2 quarters of 2025, we proactively metered spending throughout the company, which was appropriate for these unprecedented times. Given the uncertainty surrounding the new administration and a host of new EOs, we maintain tight controls on our indirect expenses. As the customer environment is beginning to settle and the pace of procurement is now picking up, we expect to return to a more normal level of spending and also aggressively invest to capture market share. Turning to the segment drivers on Slide 6. It is clear that each of our segments contributed to our impressive results.

National Security and digital revenues increased 3% year-over-year. Several contract awards from the second half of 2024 are now ramping, and we're seeing additional tasking on large franchise programs like DES. Building upon the award momentum, this segment was the primary bookings driver in the quarter. So we look for growth to sustain despite some continued DOGE headwinds for select digital modernization programs.

Non-GAAP operating income margin of 10.4% was unchanged from the prior year quarter. With the late May close, the top and bottom line contribution from Kudu was minimal as expected. The team has done a great job with the integration so far, and we're very excited about the opportunities this acquisition is unlocking. Health and Civil revenues increased 1% year-over-year, and non- GAAP operating income margin was 24.9%.

Sustaining the high levels of performance was enabled by the continued high throughput of medical disability exams and our team maintaining its laser focus on delivering excellence in innovation. In Commercial International, revenue increased 1% year-over-year from continued demand in SES, steady performance in our commercial energy business and improved execution and on-contract growth within our U.K. business. Top line growth was tempered by last year's hardware refresh in our Australian IT line of business. Non-GAAP operating income margins were 8.5%, up 780 basis points year-over-year, stemming from the anniversary of the write-downs on U.K. programs in the prior year quarter and a more favorable product mix within SES.

Last but certainly not least, Defense Systems revenue saw the highest growth, increasing 10% year-over-year from 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 called out in the earnings press release. Non-GAAP operating margins of 9.8% were down from Q2 of 2024, but up sequentially. We continue to track towards sustainable double-digit margins in our Defense Systems business. As we look ahead, we are confident in our differentiated capabilities to support key priorities like Golden Dome and Maritime.

Moving on to the cash flow -- to cash flow and the balance sheet on Slide 7. In the quarter, we generated $486 million of cash flows from operating activities and $457 million of free cash flow for a free cash flow conversion of 110%. During the quarter, we completed 2 major capital deployment activities. First, we closed the Kudu Dynamics acquisition for preliminary purchase consideration of $291 million, net of $29 million of cash acquired. And second, we finalized the $500 million accelerated share repurchase on May 20, retiring over 3.6 million shares at an average price of $138.44. These actions are perfect examples of what we're looking for as we use our balance sheet to grow shareholder value.

Opportunistically putting about half of our operating cash flow for the year to work to turbocharge our access to a fast-growing market and to take down shares at very attractive prices sets us up well going forward. We ended the quarter with $5.1 billion of debt for a gross leverage ratio of 2.2x and $930 million in cash and cash equivalents. The strength of our balance sheet offers ample capacity for additional capital deployment, aligned with the strategic priorities that Tom laid out. We will continue to monitor the market and appropriately balance debt paydown, capability-focused M&A and additional share repurchases.

Finally, on to the forward outlook on Slide 8. As you all are aware, the customer environment during the first half of the year has been somewhat unsettled. While some disruption may continue, as Tom outlined, awards are picking up and the administration is clearly moving forward. We now have greater clarity and conviction about the near- and long-term future for Leidos. As a result, we're very pleased to raise and narrow our guidance for the year across all metrics.

On revenue, we're raising the low end of our range by $100 million and the midpoint by $25 million for a new range of $17 billion to $17.25 billion. Though Tom and I are confident in the trajectory of funding and ongoing contract reviews, we have experienced some revenue reductions, and we believe it's prudent to account for some potential customer delays and other unknowns. Our performance to date gives us high confidence in our ability to deliver on margins and earnings. We are raising our adjusted EBITDA margin guidance from mid- to high 12s range to mid-13s.

As a result, we now expect non-GAAP diluted EPS between $11.15 and $11.45. So we are narrowing the range by $0.10 and increasing the midpoint by $0.75. These ranges reflect a return to more normal indirect spending and an uptick in investments we plan to make for the rest of the year to drive future growth and capitalize on the administration's priorities that are highlighted in and funded by the One Big Beautiful Bill. Lastly, we are raising our operating cash flow guidance by $200 million from $1.45 billion to $1.65 billion. The increase reflects about $50 million from better EBITDA performance and $150 million from the tax changes in the One Big Beautiful bill that allow us to immediately deduct some previously capitalized R&D costs.

All in all, the team has again showcased its drive and agility through dynamically evolving high tempo times. We remain confident in our outlook for 2025 and beyond as we execute our North Star 2030 strategy. With that, operator, we're ready to take questions.

[Operator Instructions] The first question comes from the line of Tobey Sommer with Truist.

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 thing, Tobey. Thanks, Tom here. I'll start and maybe hand it over to Chris for some additional details. We see -- generally speaking, we see the GSA taking a bigger role in government procurement as positive for the market and for the industry.

They are a professional procurement organization, and they tend to meet their schedules and have consistent outcomes. So that's good for us. And they also prefer commercial behavior, which again, is right in our wheelhouse. Frankly, we love outcome- based commercial contracts, and we're thrilled to engage with this administration throughout to increase that level of exposure for Leidos.

So generally speaking, we see ourselves as what the GSA is looking for more of, not less of. And we think we have a good opportunity to grow our business as a result. Specifically to what you're talking about from a hardware-software standpoint, Chris will maybe talk more about the details of it. But we're not a value-add reseller.

We're not a consultant. We don't make our money by buying hardware and software and passing it through on contracts. Our jam is mission systems. And so anything that lets us buy hardware and software or the government hardware and software more efficiently leaves more budget space for mission systems, which is really where we have our value add.

So generally speaking, this is a trend we're excited about, tracking closely, staying very close in contact with the GSA and are optimistic about our chances in this environment. Chris?

Yes. Thanks, Tom. And Tobey, I would just add, I mean, certainly, we meet our customers where they are, right? So depending upon how they want to procure, we're ready to support.

But as Tom said, procuring costs, hardware, software is not how we add value. It's -- today, I'd say it's on the order of several hundred million dollars on average that gets passed through to customers. Sometimes that's part of a bundled solution, and I don't see that changing. They want a particular mission outcome.

But oftentimes, if we are buying hardware or software is passed through on a cost plus or T&M basis, those margins are very low and sometimes they're 0. So again, it's not a meaningful contributor to Leidos' value add, not a meaningful contributor to our earnings or cash. And so we can flex certainly either way depending upon how that situation evolves. But we'll continue to stand ready to support our customers. And as Tom mentioned, more dependable procurements are good for everybody, and that's the path that GSA is on.

Our next question will come from the line of Jonathan [ Siegmann ] with Stifel.

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 marine time space, 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 is 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, just a couple of points there beyond maritime, right? First of all, to what Tom said, demonstration ready, pilot ready, this environment begs for what can you show me that you can feel now. And so again, with the guidance that we've laid out for the rest of the year and looking to the second half, part of the reason why we're not running at the same level of elevated earnings is we do see a rich set of investment opportunities that the teams are bringing forward to position ourselves in this environment. We're super excited about that.

Secondly, Tom and I just toured upgrades to our Huntsville campus within the last few weeks. And I'll tell you, it's very impressive. The team have laid out a number of improvements to increase throughput and capacity on a number of our product lines there, many of which are positioned to accelerate as part of One Big Beautiful Bill. So -- and again, to your point, doing all of that in a capital-light environment.

So I think we're well positioned there.

Our next question is going to come from the line of Seth Seifman with JPMorgan.

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 to 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, other customers for a long, long time and look to continue to expand our offerings to those customers here going forward.

Our next question is going to come from the line of Sheila Kahyaoglu with Jefferies.

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 4- 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 the 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. 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 [indiscernible]. 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.

Our next question will come from the line of David Strauss with Barclays.

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 have 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.

Our next question will come from the line of Peter Arment with Baird.

Tom, Chris, Stuart, nice results. Tom, could you comment a little bit on -- recently, there was a very large multibillion-dollar award to a competitor where they were consolidating IT contracts at the DoD and around AI and just whether that was something that could have an impact on your business or is not an impact to your business, just concerns about this competitive landscape changing as it's a very dynamic environment as you kind of highlighted multiple times.

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.

Our next question is going to come from the line of Mariana Perez Mora with Bank of America.

My question is going to be about Dynetics. You received $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 4, 5 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 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're alluding to that, Mariana. I mean, the VACIS equipment for border crossing, that's absolutely part of what the team is envisioning being fielded as part of that demand signal complemented by other capabilities that have emerged, as Tom alluded to, on air defense and situational awareness for radar systems, et cetera. So -- but the core nonintrusive inspection offering is well deployed on the southern and northern border.

There's opportunities to expand that footprint going forward here, and the team looks to capture significant share as those awards come forward in the fall.

And is that a driver of the favorable mix at SES? Or what is driving that improving profitability?

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.

Our next question is going to come from the line of Colin Canfield with Cantor.

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 3/4 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 2 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 is -- becomes our objective here that we'll focus on moving forward. And as it relates to growth, I mean, Tom just talked about 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.

And our next question is going to come from the line of Gavin Parsons with UBS.

Just following up on the bookings question. It seems like total book-to-bill 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. Thanks for that, Gavin. I mean, first of all, pleased that year-over-year backlog is up $5 billion, feel good about that. Tom talked about the momentum building, the big award that came in just after Q2 was over.

So nice tailwind going into Q3. And I mentioned also solidifying our follow-on extension for our MHS Genesis work. So that momentum is building. pipeline is rich. Funding dynamics, certainly, there's -- we expect that to grow, and there's been some procurement slowdowns and a move towards more incremental funding in certain customer environments. That hasn't slowed us down.

We expect the air to clear there and things to move forward on priority programs. And obligations can be lumpy at times. We also had a nice modification in our VBA business to get that funding here in the third quarter as well. So that's a nice uptick in the funding environment for that particular program.

So I just think it's a symptom of what we've seen in the environment, some slowdown, some pause, take stock, incremental reviews, some of that logjam is breaking up, and we'll see that funded backlog position accelerate as we move forward.

Yes. I would just foot stomp that last part of what Chris said. It's no surprise. We've been talking about it first 6 months that there was a certain constraint of outflow of cash from this administration during the last 6 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.

And our next question is going to come from the line of Gautam Khanna with TD Cowen.

I was wondering just big picture, it sounds like the aggressive DOGE engagement with the industry is starting to wane a bit. Is that -- would you say that's true? I mean, are we not seeing any kind of continued -- I don't know what the right word is, aggressiveness or kind of heavy handedness by the new government with the industry? And then as a follow-up, if I could just ask if the medical exam fourth supplier has finally staffed up in all 4 regions, not just the 3?

Yes, sure. Thanks. I'll take the -- I'll take a little bit of both and then turn it over to Chris. First of all, we track and have been tracking for 6 months very aggressively all the disruptions from contracts that are not only DOGE but DOGE related.

So stop works, terminations, descopes and even what we call DOGE-inspired pricing reviews. And if you track that over time over the last 6 months, while there was a reasonably high slope in that curve during the first half of those 6 months, here in the last 3 months, that's been flat. So we haven't seen increases. And in fact, that's just gross disruptions, not net disruptions.

As Chris said, the team has done a great job of taking gross disruptions and then turning lemons into lemonade by working with customers to understand how we still can serve them for products and services that they've just got to have. And so we're -- I wouldn't call it done. I still think that cost efficiency is alive and well as a part of this administration. I think now the cabinet level secretaries all have an impetus to save money and have better outcomes.

But as I've been saying for 6 months, Leidos' core business model is making government outcomes smarter and more efficient. So we see that tide turning from simply slash and burn to now constructive conversations about what better looks like and how more efficient looks like and what smarter looks like, and that's right in Leidos' wheelhouse. As far as the fourth vendor, we estimate that our share loss due to the fourth vendor so far is less than 1% of our volume. So it's not my place to understand what's happening in their business, but it's not affecting our top line or bottom line of that business yet.

Chris, 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.

All right. Just one moment, please. Our last question is going to come from the line of Kenneth Herbert with RBC Capital Markets.

Maybe just to follow up, Chris, on a comment you made earlier in the call. It sounds like you took a fairly aggressive or disciplined approach to sort of costs in the first half of the year. As things are normalizing here, it sounds like you're opening up the spigot a little bit as you really try and take -- be sure you can take advantage of the opportunity set. Is it possible to maybe quantify how we should think about that first half, second half cost dynamic and what that might imply to the margin outlook in the second half in particular?

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 4 or 5 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 keep flooding our death, 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 stop 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 culturally 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 break. We're just going to release a little pressure.

This concludes our question-and-answer session. And I would like to hand the conference back to Stuart Davis for closing remarks.

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.

This concludes today's conference call. Thank you for participating. You may now disconnect.