Leidos Holdings Inc

NYSE:LDOS

Earnings Call Analysis

Leidos Reports Strong Q2 Performance and Raises Full-Year Guidance

Leidos demonstrated a robust performance in Q2, with revenues reaching $4.13 billion, an increase of 7.7% year-over-year . The adjusted EBITDA of $559 million marked a 33% rise, achieving a record margin of 13.5% . Non-GAAP net income was $360 million, and diluted EPS saw a 46% increase to $2.63 . Strength in national security and digital segments supported this growth . Health and civil revenues surged by 22%, due to higher volumes and incentive fee awards . Leidos has raised its full-year revenue guidance to $16.1-$16.4 billion and increased adjusted EBITDA guidance to approximately 12% .

Record-Breaking Financial Performance

In the second quarter, the company achieved a record adjusted EBITDA margin of 13.5%, representing a year-on-year increase of 33%. Revenues increased by 7.7% year-on-year to $4.13 billion. This robust performance culminated in a non-GAAP diluted EPS that was 50% higher than the previous year. This significant growth was primarily driven by strong demand, effective cost management, and solid execution at the program level .

Strength Across Segments

Each segment of the business showed promising results. The National Security and Digital segment saw a 1% increase in revenue and a notable improvement in non-GAAP operating income margin by 20 basis points to 10.4%. Volume growth in key programs and strong cost control were pivotal to this success. Health and Civil segment revenues surged by 22%, with the non-GAAP operating income margin rising significantly from 14% to 24.9% year-over-year, driven by high volumes and incentive fee awards .

International and Commercial Challenges

While commercial and international revenues increased by 3%, this segment faced difficulties due to $39 million in write-downs in the UK. These write-downs were primarily due to changes in requirements and scheduled slippages on two mission software development programs. If not for these write-downs, the segment would have posted a 9.7% increase in year-over-year revenue. Nevertheless, the management has taken swift actions to address these issues, showing confidence in returning to their financial and operational targets .

Promising Future in Defense Systems

Defense Systems showed positive momentum with a 6% increase in year-over-year revenue and a 170 basis point year-over-year rise in non-GAAP operating income margins to 10.3%. The transition from development to production on key programs positions this segment as a future growth and margin driver. The company remains optimistic about harnessing the full potential of this business, anticipating a significant positive turn in 2024 .

Strong Cash Flow and Balance Sheet

The company generated $374 million in cash flows from operating activities and $351 million in free cash flow. Additionally, they repurchased $114 million in shares and paid $51 million in dividends during the quarter. The company ended the quarter with $823 million in cash and equivalents. Their gross leverage ratio improved to 2.4x, indicating strong financial flexibility .

Enhanced Full-Year Guidance

Bolstered by a strong first half, the company raised its full-year guidance. The lower end of the revenue guidance was increased by $100 million, setting a new range of $16.1 billion to $16.4 billion. Adjusted EBITDA guidance was raised to approximately 12%, and non-GAAP diluted EPS guidance was increased by $0.20 to a new range of $8.60 to $9. Operating cash flow guidance was maintained at approximately $1.3 billion .

Looking Forward

CEO Thomas Bell discussed the substantial progress made in instilling a 'promises made, promises kept' culture, improving previous acquisitions' performance, and enhancing business capture capabilities. These factors contribute to the company's promising outlook. Elevated by strong segments, effective cash management, and a robust pipeline of government contracts, the company is well-positioned for continued growth and profitability! .

Earnings Call Transcript 2024-Q2

[Operator]

Greetings. Welcome to Leidos Second Quarter 2024 Earnings Conference Call. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I'll turn the conference over to Stuart Davis from Investor Relations. Stuart, you may begin.

[Stuart Davis, executive]

Thank you, operator, and good morning, everyone. I'd like to welcome you to our second quarter fiscal year 2024 earnings conference call. Joining me today are Tom Bell, our CEO; and Chris Cage, our Chief Financial Officer. Today's call is being webcast on the Investor Relations portion of our website, where you'll also find the earnings release and supplemental financial presentation slides that we'll use during today's call. .

Turning to Slide 2 of the presentation. Today's discussion contains forward-looking statements based on the environment as we currently see it and as such, includes risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially.

Finally, as shown on Slide 3, during the call, we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the 2 is included in today's press release and presentation slides. With that, I'll turn the call over to Tom Bell, who will begin on Slide 4.

[Thomas Bell, executive]

Thank you, Stuart, and good morning, everyone. It's great to be with you all again today to report a record quarter for Leidos. In this quarter, organic growth remained strong, achieving a record adjusted EBITDA margin of 13.5%. Year-to-date, we've delivered industry-leading profitable growth with adjusted diluted EPS 50% higher than last year. The team is doing an excellent job converting our earnings into cash. In turn, this has allowed us to continue to deploy capital to grow shareholder value per our plan. We're now halfway through our commitment to repurchase $500 million worth of shares this year. I'm also proud of the fact that this robust first half of 2024 allows us to once again raise guidance for the full year. Chris will give you a complete update on our financials, and our guidance later in the call.

One year ago, on my first call with you all, I laid out 4 focus areas to begin Leidos' journey to best-in-class performance. Instilling in Leidos, a promises made, promises kept culture, sharpening our strategy, improving the performance of previous acquisitions, and enhancing our ability to win new business. I'd like to take this opportunity to update you on the meaningful progress we're making in these areas. I see this progress as foundational to putting ourselves in a great position to execute our forthcoming Leidos North Star strategy.

First, our team has fully embraced a promises made, promises kept philosophy. As part of this, we've made a firm commitment to each other to drive operational improvement, profitable growth and robust cash conversion. The evidence of this culture taking hold is clearly visible in the 12-month trend of our results and our second quarter results summarized earlier that are simply our best yet.

Our currently strong and strengthening balance sheet puts us in an excellent position to continue to allocate capital prudently over time to grow shareholder value. Further share repurchases this year are possible. But at the same time, I must say that our new North Star strategy work is beginning to bring into focus exciting and compelling growth opportunities potentially worthy of investment. This brings me to that second focus area creating our new North Star strategy. While we continue to deliver robust in-year program execution, we are also aggressively prosecuting our year of deep strategic thinking and the energy and insights that are beginning to come into focus because of our purposeful strategy process are very intriguing.

We've now completed work on the Leidos proprietary hypothesis of the future. Our own exclusive prediction of the challenges our customers will face, the solutions those challenges will require and the technologies we must create and harness to best differentiate our solutions for our customers. Informed by our hypothesis of the future, we're now halfway through crafting a new business strategy for Leidos. This strategy will both leverage and enhance our current core businesses and uniquely position us for outstanding success in the future we foresee.

One clear component of our strategy will remain our focus on technical differentiators, our golden bolts. Technological innovation is and will remain a cornerstone of Leidos. And our enterprise-wide technology investments are now more than 1% of total revenue and growing. At our recent Investor Technology Day, we went in depth on 1 of those golden bolts, trusted mission AI. Those of you who were able to join us witnessed firsthand, our brilliant team in action demonstrating how we use trusted mission AI to drive productive disruption across our customers' missions.

We believe that when it comes to AI, the mission is the market. So everything we do as the #1 provider of IT to the federal government and the #8 U.S. defense contractor is an opportunity to exploit and deploy trusted mission AI for our customers' mission benefit. Another area of proactive investment for us remains cybersecurity. For instance, we've been investing in Zero Trust for years before there was a requirement for it to be adopted by federal agencies. As a result, over the last 3 years, we've received more than $5 billion of awards that cite our Zero Trust methodology as a differentiated strength.

We're currently pioneering the application of Quantum Technologies to enable highly secured networks. We're executing contract R&D for DARPA in this area and investing in post-quantum encryption technologies and solutions. These will ensure our customers can rapidly respond to future developments in quantum computing. These examples give you some understanding of our forward-looking approach to the market and our track record of investing ahead of demand.

Third, we're on track to unlock the strategic value from the large acquisitions we made in 2020 and 2021, specifically Dynetics and security, detection and automation. On Dynetics, we have doubled down on 3 specific areas. Each of these now on a robust positive trajectory. In satellite payloads, we're a key supplier to the Space Development Agency's wide field of view sensor program within its proliferated war fighting space architecture. We have delivered all our payloads for tranche Zero and those payloads were the first ones in low earth orbit, providing FDA actual on-orbit imagery.

In addition, we remain on track to deliver our Tranche 1 payloads in early 2025. And we are teamed with Sierra Space to be their payload provider on their tranche 2 birds. The Space Development Agency has recently issued their RFI for tranche 3. So in sum, we believe our current comprehensive role on all 3 existing tranches and our current actual emission performance in space position us well to continue to deliver for this critical and expanding mission. On force protection, we've delivered 14 if pick and during Shield prototypes, which are successfully working their way through government testing.

The Army recognizes this system's unrivaled air defense capability, and we expect to receive awards soon to begin low rate production in 2025 and full rate production in 2026. And in hypersonics, the United States continues to progress in developing and fielding hypersonic weapons. Leidos is supporting this progress by developing -- delivering technology advances through our common hypersonic glide body and MOCTV programs. These programs play a critical role in accelerating the pace and scale at which we can produce, test, assess, advance and field our nation's hypersonics capabilities. We remain on track for our common hypersonic glide body and thermal protection systems delivery.

And all in all, we feel quite positive about this robust pipeline of opportunities in hypersonics. So 2024 maintains its promise to be a good year for the maturation of these programs. And we're also seeing our focus here translate into better financial performance. Our Defense Systems profitability was double digits in the quarter, our first time at that level of performance from as far back as we recast financials in the new organizational structure. Turning to security products. The SD&A acquisition is now fully integrated into our SES business area. Though challenges remain, SES is on sound footing because of the swift actions of our new management team and that they took last year.

We have focused our efforts and investments in product lines and geographies that make the most sense for Leidos and therefore, our shareholders. Our new Charleston manufacturing facility is up and operational and we're performing better against our service level agreements with our customers. We've had solid bookings this year and more consistent deliveries of large border solutions. As a result, SES is ahead of plan for revenue and earnings for the quarter and the year. SES revenues are up 11% year-to-date, and we've achieved almost 90% of last year's non-GAAP profit in the first 2 quarters of 2024 alone.

A common theme of this improved acquisition performance is the new organizational structure, which brings better alignment of sector resources and new leadership with an increased emphasis on execution and promises made, promises kept. Fourth, we continue to make significant progress to enhance our business capture performance and backlog quality. We've achieved net bookings of $4 billion this quarter with a heavy emphasis on cyber and Digimo awards with a book-to-bill ratio of 1.0. We also have nearly $3 billion of awards currently under protest. We ended the quarter with total backlog of $36.5 billion, including $8 billion of funded backlog.

While this quarter's performance adequately supports our 2024 growth commitments, we are not at all satisfied. And our growth teams have been working diligently to reignite our winning ways here at Leidos and do much better on top line growth soon. An element of this is strengthening our customer-centric framework of account management. Over the past 6 months, we've hired dozens of key account managers and frontline growth leaders each with deep mission and customer expertise in areas of strategic importance.

Each of our account managers have a front-line obsession and seamlessly integrate across both our P&Ls and our office of technology to ensure we couple best-in-class teams with best-in-class technical solutions. Two examples which illustrate this point are our recent hires for IndoPaycom and Aukus. Because of their respective hard work in very short order, we've won strategic awards to support military exercises that are fundamental to the U.S. Pacific deterrent strategy. Maritime Autonomy and underseas sensors work in Australia and hypersonics work in the U.K. that fit within Aukus Pillar 2.

And U.S. Navy submarine trainer development efforts that fit within Aukus Pillar 1. We've taken the further step of dedicating some 100 of our top engineers and solution architects to our frontline growth efforts. Operating in full partnership with our account managers and capture teams, they are positioned to bring the best of the best of Leidos to our customer needs. With the improvements we're making in the growth value stream, we are getting set up for a much better business capture performance in the future. At quarter's end, we had $26 billion worth of bids awaiting adjudication. And more importantly, quality is improving dramatically. Our pursuits are more aligned with our strategic direction, our proposals demonstrate greater customer understanding, and we are doing better at pulling through enterprise-wide technical expertise into each customer solution.

So in summary, I'm very pleased with our financial results this quarter and the momentum that we're carrying into the back of the year. We're making great progress on our current 4 focus areas. This puts us in an excellent position to execute our emerging Leidos North Star strategy. I'm very proud of the 48,000 Leidos teammates who collectively every day and sure Leidos is making smart smarter for the benefit of our customers. And I'm honored that every day more and more of the best of the best, we could smart people in the nation, join Leidos to break limits. I'll now turn the call over to Chris to walk you through our financial results in detail. He'll also provide insight into our upgraded outlook for the year, and then we'll be pleased to take your questions. Chris?

[Chris Cage, executive]

Thanks, Tom, and thanks to everyone for joining us today. Our second quarter results demonstrate yet again the power of our focus on profitable growth and cash generation. With clear intent, our team is driving current financial performance while also building for a more prosperous future. Turning to the income statement on Slide 5. Revenues for the second quarter were $4.13 billion, up 7.7% year-over-year. .

Robust revenue growth reflects the benefits of both the strong demand environment and historically low levels of attrition. The highlight for the quarter was margin performance. Adjusted EBITDA was $559 million for the quarter, up 33% year-over-year, and adjusted EBITDA margin increased 260 basis points to 13.5%. We achieved this record margin through business mix and intra cost management. Program level execution was generally very strong, but EAC adjustments were a net $12 million headwind -- non-GAAP net income was $360 million, and non-GAAP diluted EPS was $2.63, up 43% and 46%, respectively.

Below the line items had no material impact on net income or EPS. Turning to the segment view on Slide 6. National security and digital revenues increased 1% year-over-year. We saw volume growth on our Sentinel and DES programs as well as several contracted research and development efforts. You may also recall that last year, we had spikes in some of our large digital modernization programs notably NGEN and Aegis, which created a tough year-over-year comparison. National Security and Digital is also the segment most impacted by protest.

Still, accelerating growth in national security and digital is a major focus of the ongoing strategy discussion. National Security and Digital non-GAAP operating income margin increased 20 basis points from the prior year quarter to 10.4%, with some milestone achievements, strong cost control and excellent program execution. For the first half of the year, national security and digital has been solidly ahead of plan on profitability. Health and Civil revenues increased 22% over the prior year quarter, and non-GAAP operating income margin came in at 24.9%, up from 14% a year ago.

The primary driver of revenue growth and increased profitability was higher volumes across our managed health services portfolio and an extra quarter of catch-up on incentive fee awards on our DBA disability exam contracts. Commercial and international revenues increased 3%, paced by an uptick in deliveries on security products, higher volumes in our commercial energy business and a hardware refresh in our Australian IT business. These drivers offset $39 million of write-downs in our U.K. business, primarily on 2 fixed-price mission software development programs caused by changing requirements and scheduled slippages.

The U.K. write-down suppressed non-GAAP operating income margin to 0.7% in the quarter. Absent these write-downs, commercial international would have posted 9.7% year-over-year revenue growth and non-GAAP operating income margins of 8%. Although these write-downs are disappointing, they underscore the rationale for the new organizational structure. The C&I team is bringing greater focus on programmatic execution within the international portfolio, and they quickly took action to ensure the long-term success of our U.K. operations.

We're confident that we'll get back on track towards our financial and operational objectives within the U.K. And on balance, we remain encouraged by the strong performance and demand signals across our Commercial and International segment. Finally, in Defense Systems, revenues increased 6% over the prior year quarter on a total basis and 7% organically. And non-GAAP operating income margins increased 170 basis points year-over-year to 10.3%. Tom touched on the improvements the segments making on program execution and it is good to see the kind of financial performance that we expected from this portfolio.

As we transition from development to production on some key programs, we see Defense Systems as a growth and margin driver for Leidos. We're making great strides towards unlocking the full potential of this business and are optimistic that 2024 marks a significant turning point towards a brighter future.

Turning now to cash flow and the balance sheet on Slide 7. We generated $374 million of cash flows from operating activities and $351 million of free cash flow. We had our highest collection week ever, which led to the exceptional Q2 performance. Overall, we're seeing a strong focus on cash throughout the organization. DSOs for the quarter was 58 days, an improvement of 1 day from a year ago and 4 days sequentially. In Q2, we repurchased a total of $114 million in shares, including $100 million on the open market and paid $51 million in dividends. We ended the quarter with $823 million in cash and cash equivalents and $4.7 billion of debt. Our gross leverage ratio now sits at 2.4x, which gives us plenty of financial flexibility.

Next, I'll go through our enhanced outlook for 2024 on Slide 8. We're raising the lower end of our revenue guidance by $100 million, which gives a new range of $16.1 billion to $16.4 billion. We're increasing adjusted EBITDA guidance to approximately 12% and we're raising our non-GAAP diluted EPS by $0.20 to a new range of $8.60 to $9. Our guidance for operating cash flow remains at approximately $1.3 billion for the year. This enhanced outlook reflects our strong first half performance as well as broad-based momentum across the entire portfolio.

But let me walk you through some of the drivers of the second half performance for we're modeling. Clearly, we're seeing strong momentum in our managed health services business. Last call, we signaled some potential second half revenue and margin headwind in our VBA disability exam business based on an upcoming recompete, which remains ahead of us. In addition, the unprecedented caseload of disability claims spurred by the PACT Act is straining the VA's budget resources.

Earlier this month, the VA urged Congress to approve $15 billion to fund budget gaps in government fiscal year '24 and 2025, or risk cuts to veterans benefits and care. The VVA customer has implemented several measures to proactively manage through these budget challenges, including dialing back its internal staffing, which suppresses industry case volume. We're already seeing the impact of this change with reductions in our near-term case backlog. Given that veterans benefits work is funded through mandatory, not discretionary budgets, and caring for veterans as broad bipartisan support, we expect underlying case load to rebound in our fourth quarter.

Notwithstanding this temporary funding issue, we stand ready to continue to deliver exceptional service to the nation's service members as a trusted mission partner to the VA. We expect commercial and international margins to snap back in the second half and for national security and digital margins to moderate somewhat consistent with our commentary on the last 2 calls. And lastly, in the back half of the year, we've stood up a robust innovation fund focused on growth. Our bottom line performance puts us in a favorable position to accelerate investments across the business as seed corn for our emerging strategy to continue to drive sustainable, profitable growth.

With that, operator, we're ready to take some questions.

[Operator]

[Operator Instructions]

And the first question coming from the line of Mariana Perez Mora from Bank of America.

[Mariana Perez Mora, analyst]

So my first question is on managed health care. And the margins there and incremental margins, they are really, really strong. How should we think about what is the moat that you guys have as you go ahead to this like competition and recompete coming. Because I could imagine like the installed base you have that actually allows for these incremental margins actually post a really strong moat. But what else from a technical perspective, you think that you have in your advantage to keep a good share of like this really growing market?

[Stuart Davis, executive]

Thanks, Mariana. Really appreciate your question. And obviously, a part of the portfolio we're very, very proud of. The performance we're achieving in this part of the business is directly related to our passion to serve the nation and its veterans. And our investment in technology is ahead of curve so that we were poised to take additional volume as we came out of COVID and had an opportunity to serve more and more veterans.

We're very proud of this, and we're very proud of those investments that allow us to serve more veterans and our modeling for what the output and input of veterans that need case management increases and stays the same over the coming years. So we're very bullish on the absolute volume. What we're doing to affect our future in that overall volume is ensuring that the VA sees us as their partners. So we've leaned in to help make sure that they understand we are invested in their success and their budgetary challenges that they have right now.

And that positions us well for this recompete that's coming in the third or fourth quarter, probably more like the fourth quarter. We expect the customer to expect us to continue to serve the veterans the way we are. And we're very bullish about the opportunity for us to continue to invest in technologies that serve our customers even better. So the challenge that we've given Liz and her team is not how to hold on to this business, but how to increase this business over time. So as part of our year of deep strategic thinking, we're not seeing 2024 as the peak of this business. We're seeing it as a plateau of this business from which we continue to springboard that's the challenge we've given Liz and her and her team are responding very favorable to that.

[Thomas Bell, executive]

Chris, do you want to add anything?

[Chris Cage, executive]

Yes. Mariana, I would. Tom touched on the technology aspects. And clearly, that's been a major focus that we've added to the equation under Liz and Larry Shapers leadership over the past several years. But beyond that, we've been a long-standing partner here. We've won this recompete multiple times over. There's investments that we've made in physical locations, mobile locations, provider networks, critical staff, all of those things come to bear. And then, of course, the customer is going to evaluate what has your performance been? And clearly, we can demonstrate a track record of strong performance with great customer satisfaction, great accuracy, throughput, all of the key metrics the VA is looking for.

So we're sharpening our pencils to make sure that we're putting ourselves in the best position possible to defend this critical work for ourselves. But obviously, it's an area we feel very encouraged about our position on.

[Mariana Perez Mora, analyst]

And if I may, my next question is about, as you focus on the account managers and capture these things what are the challenges you have on hiring and training the talent, both in terms of people that you hire?

[Thomas Bell, executive]

There's really a war for talent of these type of people. But we are bound and determined, as I've mentioned on previous calls, to make sure Leidos is the destination of choice for the best and brightest talent that's out there in the ecosystem. And so what we've started to see, I mentioned we've hired dozens of these account managers, and we've allocated hundreds of people to be our solution architects for our new solutions, we have an environment in Leidos that is compelling. We are an employer of choice.

And the more we win, the more people will want to be on the winning team. So it's not so much a question of challenges. It's a question of helping them understand the opportunity that's in front of them for joining Leidos and the investment we're going to make in them to make a difference. People that are in this line of business are in this line of business because they want to serve their customers. And the most disenfranchising thing you can do for a customer -- for a person who is passionate about serving customers is not fully support them.

So Leidos is creating an investment strategy, and we're investing in the people, processes and tools that allow them to affect their customers positively and bring solutions to them differentially. And that is the most compelling thing about coming to work for Leidos that we're hearing from others and attracting great talent as a result.

[Chris Cage, executive]

The only thing I'd add, Mariana, to that is, of course, a very good question. And Tom's right. I mean screening the right people to have the passion to want to serve the right customers missions is critical. Area that we need to help them the most as they get into Leidos, there's clearly a tremendous amount of capability that we have that can be brought to bear to support those customers in multiple ways helping them understand the breadth of our offerings is an area that we are continuing to invest in. And that's the reason why partnering them up with so many solutions architect and other people that have been down that road is critical, but there's technology that's behind that as well.

So Gerry Fasano leads our growth office. He's very focused on that rollout plan, and we're excited about that taking a lot of momentum here in the second half of the year.

[Operator]

And our next question coming from the line of Matt Akers with Wells Fargo.

[Matthew Akers, analyst]

Thanks for the question. Tom, I wanted to follow up. You talked about kind of some of the portfolio pruning initiatives you're kind of looking at. Kind of could you give us an update on where we stand there and kind of what inning we are in that whole process? .

[Thomas Bell, executive]

Yes, sure. Thanks, Matt. As I said in my prepared remarks, we're done with the Leidos proprietary hypothesis of the future. This is our own exclusive proprietary view of what the world looks like in 2033 and therefore, what are the challenges our customers are facing in 2028 in order to affect that future. We're halfway through building our business strategy as a result and affected by that view of 2028.

So it's very much a today, forward view and a future backview meeting in 2028. As we are starting that, Chris trailed in his comments that we've put a small investment fund out there because ideas are starting to emerge from this year of deep strategic thinking that we know are winners. These are areas that we are going to be investing in, in the future. And although we're not going to articulate it, we're putting C corn out there now in those areas so that we're not waiting for the whole process to be done to do the obvious compelling things we want to do to affect our future here. So we're very excited about that.

Now the overall objective and the parameters of our year's deep strategic thinking, I think I mentioned it in our last call, it's not going to be a pivot for Leidos, a 90-degree pivot or a 180-degree pivot. It's going to be variations on the cores that we're in now. And so we're going to be doubling down on our core strengths. We're going to be really focused on repeatable business models. We're going to really focus on speed. We know that our customers are very concerned with speed, but they're concerned also that the people they hitch their wagons to have to have the scale to solve complex problems differentially. So speed and scale, trusted mission AI.

There's a reason we had a whole day focused on trusted mission AI because we think it is a compelling technological unlock for the futures our customers are facing across all the markets that we serve. And we're going to continue to look for those areas of white space that are adjacent to the current businesses we're in for investment. Now obviously, Matt, in the spirit of your question, there's also going to be parts of the portfolio we are not going to differentially invest. I've mentioned this in calls last year. I do not believe in spreading peanut butter around and watching every flower bloom. I think all about differential investment for differentiated results.

But there is also not any part of the business yet that is raising its head in the strategy process is saying it's obvious this does not belong in Leidos. So don't think of this as portfolio pruning, Think of this as simply investing to maintain, investing to grow and investing to grow exponentially. That's the way we're thinking about our strategy process. All that will be discussed full in our March Investors Day that we look forward to welcoming you to.

[Matthew Akers, analyst]

Great. That's helpful. And I guess if I could do 1 more, just lay the stuff on upcoming recompetes, anything big that we should be watching for this year?

[Chris Cage, executive]

Yes. Matt, obviously, we talked a little bit, of course, about the VBA exam business, and that's top of mind as we navigate to the end of Q3 into Q4. Beyond that, I mean, there's not as many needle movers. There is an exciting opportunity in the hypersonics arena or common hypersonic glide body and TPS contracts converge, and we look forward to extending our work there with an important customer. There is an integrated logistics support contract with the TSA that whether it's late this year or first quarter next year.

And obviously, you can imagine that's a partnership between our C&I business and work we do elsewhere that specializes in the logistics side. And then looking ahead to next year, I think the other big 1 I'd point out is the DHMSM contract. The follow-on to that, obviously, is an important piece of work for us. The team is already in the proposal fits, making sure that we're putting our best foot forward, but that is sometime in the middle of 2025, early to mid '25.

[Thomas Bell, executive]

And just to pile on a bit, Matt, sorry to have a Reclame here. Color for our pipeline. We've got billion in submits in the second quarter. We've got $26 billion plus awaiting customer decisions. In the next 12 months, we have a pipeline of almost $70 billion and our whole qualified pipeline approaches $200 billion. So we're very excited about the opportunities to grow and that's why we are very much focused on priming the pump of our business capture teams with talent who can differentially go out there and get this business.

[Operator]

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

[David Strauss, analyst]

Question Tom, on national security and digital I think you guys hit on the slow growth there in the first half, but it sounds like you're talking about acceleration in the second half, but at the same time, it sounds like you're signaling lower margins in the second half. So can you just dig in exactly kind of what's going on there in the second half versus the first half?

[Thomas Bell, executive]

Yes. Our national security and digital segment is arguably the core of the core of Leidos. And it is an area that we've put 2 of our most talented leaders, Roy Stevens and Steve Hall. And they are partnered to make sure that we are focused on how we help our customer in deterrents and being the smartest government on the planet. We don't think that there is a challenge here with the pipeline. Obviously, this is a business where we've won in the past. We know we can win in the future. .

The margins in this type of business are never going to be over the top. They're going to be in the low double digits. But what we have in this segment, in my mind, David, is a revenue growth story. There is much more we can do to help our customers in these areas. And our customers, this comes back to the speed and scale conversation I had before. Our customers are increasingly aware of the fact that the scale of the problems that they have requires people who have speed and scale to solve them. So Roy and Steve are partnered with the whole enterprise with Jim Carlini in technology and Gerry Fasano in growth to make sure that we're leaning into serving our nation in this area and not looking to back off in any way. So if we gave you an indication of softening here, that's probably not the guidance we'd want to give.

[Chris Cage, executive]

Yes, David, I'd just add on to that. I mean I think part of that is because we had an excellent first half of the year on margins. And there are some things that can move around, around milestone timing and things of that nature and how much special project work we see on programs like NGEN. But there's no fundamental issues here. And in fact, we're actually very encouraged. To Tom's point, this will never be our highest margin business, but we do see upside here over time. And the teams are investing in more repeatable models in the Digi mod space and those will be some unlocks to future margin upside that we're expecting.

But I don't want to overlook some important wins that did take place in the quarter, getting the next defense enclave services task order under contract is critical for us. That is a key unlock for Steve and his team to drive growth into that important program. So that clears the way for 13 additional DoD for the state agencies to migrate on to the network over time. So we've been waiting for that, and we're excited about what comes behind that as we get into '25 and beyond.

[David Strauss, analyst]

Great color. Chris, a quick follow-up. You noted the pretty good working capital performance in the first half of the year relative to the prior year. How are you thinking about working capital through the rest of the year?

[Chris Cage, executive]

Yes. So I'm very pleased with the team's performance on cash management. I think we've done an excellent job. And last year, we made some really strong gains on managing the payable side. And more industry standard terms with our vendors, and we've made some more progress in that regard this year. We've been attacking the DSO side. I would say it's steady as she goes. I don't see anything at this point in time that would be a major use of working capital. We're always interested in great ideas that could be accretive to the business. But right now, we're focused on Q3 and Q4 are usually our strongest performance quarters. And I affect this year to follow suit.

[Operator]

Thank you. And our next question coming from the line of Cai von Rumohr with TD Cowen.

[Cai Von Rumohr, analyst]

Thanks much Tom, terrific results. You guys have mentioned that we expect health -- the medical exam business is not at a peak, it's at a plateau. But given moat at least early on next year, we'll be under the new contract. Should we assume that the margins are going to be lower because I assume it takes time until you get to the point where you kind of are doing well in terms of the incentives and all of that. So is it likely that profits and health will be down next year?

[Thomas Bell, executive]

I hate to answer your question this way, but we don't know is the real answer because we're awaiting the RFP that tells us what the customer actually wants to do. We know that the contract comes to an end at the end of this quarter. We are awaiting the RFP for the future. We're not sure if that's going to be -- if we're going to have an extension to the current contract, a new contract for a fixed period of time or a new contract for a long period of time. And we don't know how the VBA is going to incentivize industry to bring its best and its most throughput to our veterans. So we have no reason to model in our own minds, a decrease in profitability, but there is a big unknown while we await the RFP.

[Chris Cage, executive]

Yes Cai, I'd only add, I mean, what we do know is that the BDA has asked Congress for more money, right? And that's a strong signal that they see the demand out there, more veterans need care, need throughput. And that's always been the priority. Now we're in a call it, a temporary situation where they have to navigate this funding gap. Tom is right. I mean a lot of things will become clearer for us as we get through the next quarter or 2. But you can imagine that our early conversations with our health team about '25 is how do we grow off of '24 levels. And that's the way we're approaching it. And so everybody's clear eye around looking at every opportunity to make sure we optimize our performance levels there and elsewhere to continue to grow earnings.

[Cai Von Rumohr, analyst]

One quick 1 on your new business. You had $15 billion of submits, you have $26 billion awaiting, what should we think about in terms of your book-to-bill? You also have $3 billion in process, I think, is a big classified award in there. Should we see book-to-bill pick up in the second half? And are you guys chasing some of the large takeaways you've been so successful in.

[Thomas Bell, executive]

The team remains committed to a book-to-bill ratio slightly better than 1 for the year of 2024 and they are determined to meet or exceed that. There are some big swingers in there, and it's possible that if many of these break our way will far exceed the book-to-bill ratio that they have. But Cai, again, in my earliest call, I talked about the fool's mission that chasing quarterly book-to-bill was in my mind. And the fact that what we should be focused on is building a quality backlog over time of profitable business. And that's really what I'm more incentivized and really focused on with the business capture team.

How do we look at that trailing 12 months of book-to-bill? And how is that looking at our future growth potential with the backlog that we've got on the books. The team is very focused on that. As I mentioned in my prepared remarks, we're doing a better job of bidding for the things that will reward Leidos adequately for the technology and the capability we bring and I feel as if many of those that are in our backlog will start to break our way. So we're very bullish on the future without getting ahead of our SKUs.

[Operator]

And our next question coming from the line of Peter Arment with Baird.

[Peter Arment, analyst]

Terrific results. Tom, maybe just to focus on commercial and international, just you had the write-down in the quarter. Absent the write-down, you would have had pretty good margin performance maybe just talk a little bit about, I guess, either the write-down on just confidence level in kind of the back half of the year, where your margins are, I guess, expected to be better.

[Thomas Bell, executive]

Yes, sure. Thanks. Well, first of all, this is very much the benefit of having new eyes and a new organizational structure that's looking with fresh perspectives on the business. As Chris mentioned, this is primarily 2 fixed price contracts that we have in the U.K. that through increased and very robust conversations with the customers, we've decided we have to take a write-down because of changing requirements and a scheduled slippage, but we feel confident that we've also taken a lap around the block and looked under the rocks to make sure that there's not more.

So Vicki and her team are doing a great job scrubbing the portfolio. She's cut the number of watch programs in her portfolio by half in these first 2 quarters, and we feel very bullish about the prospects for her business. I mentioned and I featured in our last call, last quarter that we want to make Leidos synonymous with Aukus Pillar 2 and as you heard in this call, we've taken some steps by really allocating and hiring some talent that can really get after making that so. So Vicki and her team are very focused on bringing the team together around Aukus. We've got excellent customer touch points in the U.K. and Australia and obviously here in the United States, and we're very bullish on the opportunities for commercial and international.

Also, I want to tip a hat to the SES team. They had a very good first half of the year. And that is all credit to Mike Van Gelder and to Vicki, who have really gotten their arms around that business and really make sure that we are on a solid platform from which to grow. So very optimistic about where that business is heading in her portfolio also.

[Chris Cage, executive]

The only thing I'd add there, Peter, is the piece of the business there that Tom didn't mention is our commercial energy business, and that has been performing extremely well and tends to have a pattern where the back half of the year is stronger on a margin basis. There are some critical incentive and award fee determinations that happen sometime later in the year. So a well-run business that we expect to continue to deliver great results. And the other piece of the portfolio, we believe are on strong footing for the second half.

[Peter Arment, analyst]

That's very helpful commentary. And then just Tom, just quickly, the DoD continues to make a lot of evolving changes or strategies around counter-UAS and I know that Leidos Dynamics has some exposure here. How are you guys thinking about the portfolio and when you're thinking about the counter UAS business today?

[Thomas Bell, executive]

It's a very timely question, Peter. I have a classified briefing later this week to dive deep into all our capabilities for counter UAS. Obviously, if pick and -- during Shield is the thing we talk most about, about Dynetics. But within our Leidos Innovation Center, the Link and our Defense Systems segment, we've got a myriad of other technologies that can affect Counter-UAS capabilities for our customers. So we're going to take a step back kind of look at everything that we've got in the pantry when it comes to technology and decide are there some things we should be investing in this year to help our customers with this very, very vexing problem that they're uncovering now. So very bullish about our opportunity to serve. The question is do we have something in the pantry that will be compelling for the customer. .

[Operator]

Our next question coming from the line of Jason Gursky with Citi.

[Unknown Analyst]

Jeremy Jason from Jason Gursky's team. Could you walk us through the pipeline for each of the segments for '25 and '26. And kind of give us an update on production capacity and how that might impact growth outlook.

[Chris Cage, executive]

Jeremy, Tom gave you some high-level metrics. We're probably not going to be able to dissect the pipeline by segment by year for you. But rest assured that we feel it is robust in each of the segments has opportunities north of $1 billion all the way down to some strategic small opportunities in the tens of millions of dollars. So we like our positioning there. The big ticket numbers again, $26 billion pending, $200 million overall pipeline, approximately $70 billion. We expect to be decided in '25, 2/3 of that being new work and take away, great position on our BD side and the growth teams are highly energized.

As it relates to production capacity, the good news is the Dynetics team had built up some capabilities down in Huntsville. We feel like we've augmented that in areas like the white field of satellite payload needs. We've got a facility that we've been waiting to fill up from a capacity standpoint on the -- side, the enduring shield. So we're excited about the ability to take full advantage of what we've got in place there. And then we spoke previously on the SES side about our new Charleston facility that we toured just in the last few months. It's a great facility that the team's built out. And in fact, there's plenty of room to expand capability even in the footprint that we built out.

So I don't see a big need on major investments in those areas. It's always something that we look at and we're happy to entertain great ideas if there's a compelling expansion to the pipeline, but we're in good shape to be able to expand up to the needs that we foresee over the next 18 months or so.

[Thomas Bell, executive]

Yes. And just to pile on a little bit on that, Jeremy. The $26 billion of pending awards we have, I mean that is not only several home runs that we've got on deck, but 40, 50 big awards of $50 billion -- $50 million or more. So we've got lots of proposals in work. And so the batting average should be relatively positive on that. We've used the example internally of -- we've had a business capture problem. And so to break that inertia, we have imputed energy, energy with new talent, energy with new processes and tools. And now we're very excited about the momentum that's going to build over the next 12 to 15 months. You'll appreciate that in our customers' environment, decisions take time. And ultimately, they're almost all protested. And so it takes a little while before a flash of energy to break inertia becomes the bang of the momentum of actual wins, but we're highly confident that we're in a good place, and Jerry is the right leader to bring us forward.

[Operator]

And our next question coming from the line of Ken Herbert with RBC Capital.

[Kenneth Herbert, analyst]

Tom and Chris, really nice quarter. I just wanted to first start off. You obviously raised the guidance with the exception of the cash from operations. Is there anything in particular when you think about the cash flow outlook in the second half of the year we should keep in mind or make driving a little bit more conservatism there?

[Chris Cage, executive]

Yes. Ken, Chris here. Obviously, we stepped up our cash guide last quarter by $200 million, a pretty significant increase, we're clearly focused on converting these extra earnings that you're going to see here into cash. And there's always the chance that some of that comes in, in January versus December. So at this point in time, with 2 quarters to go, and 2/3 of our cash commitment for the year ahead of us, we just didn't feel it was prudent to increase the guidance at this time. But there's no headwinds that we're foreseeing. We're just kind of managing it down the middle.

[Thomas Bell, executive]

And just to build on that, right, at the beginning of the year, we talked about the uncertainty in the market heading into an election year. Obviously, we're still dealing with some uncertainty. We're still dealing with customers that have budget challenges and issues around their performance of their business. And so -- while we're extremely pleased with the first half of the year that allows us to raise our guidance again, we're not going to get ahead of our skis or overpromise. We're going to keep our powder dry to make sure that the third and fourth quarter deliver the way we expect them to.

[Kenneth Herbert, analyst]

That's great, Tom. And if I could, the -- it sounded like from your prepared remarks that there could be upside as well to the expected buyback this year, the $500 million. I guess maybe part of that is timing. But can you just reset in terms of what you might want to see to deploy more capital there? And maybe any change in how you think about the framework around returning capital to shareholders considering some of the investments you're talking about here today. But great cash in the quarter, really nice.

[Thomas Bell, executive]

Yes, sure. And great cash in the quarter is the reason that I only trailed it and didn't commit to more. We had great -- you know how the flow of the business comes. It's a little bit like a sign wave when it comes to cash coming in. And typically, the third quarter is a relatively robust cash quarter for our business. We had a very robust second quarter. So I recommitted -- we're committed to repurchasing $500 million worth of shares this year. We're halfway through that now. We'll continue that program. If the cash comes in per historical norms in the third quarter, that may give us a chance to revisit it. But more on that as the third quarter unfolds, and we look toward the fourth quarter. .

The 1 thing I will say, Ken, just because to state the obvious, but not to assume it is stated, fear not. We're going to be -- continue to be prudent allocators of cash in a shareholder-friendly manner. And so don't worry about this burning a hole in my pocket as my grandmother used to say.

[Operator]

And our next question coming from the line of Noah Poponak with Goldman Sachs.

[Noah Poponak, analyst]

Good morning, everyone. So I guess the EBITDA margin has to be a lot lower in the second half than the first half to be at the 12% for the year in the second half EPS as a percentage of the total would need to be a lot lower than it's been historically to be in the earnings range for the year. Obviously, the health and civil margin pretty strong in the second quarter, but you're also absorbing this C&I margins. So can you maybe, Chris, just walk me through that? I mean what -- which segments revenue growth or margins really moderate a lot, how are you thinking about that health margin through the back half of the year?

[Chris Cage, executive]

Sure. No. Thanks, Noah. And we get it, right? Excellent first half of the year, excellent full year guidance, but the second half relative to the first half looks a little bit more modest. But stepping back, the guidance implies, let's call it, roughly 11% margins in the second half of the year. And just 6 months ago, we opened the year with an expectation of 10.5 to high 10s on margins. So we're pleased to be able to look ahead and say, even in a scenario where the disability examination work levels perhaps come down, we still see line of sight to, let's say, 11 percentage margins kind of being delivered by the business. .

And that's really the primary reason, right? As we look at -- as the VA is kind of navigating the next few months, we're expecting those -- the throughput to be lower and then we've allowed ourselves some cautiousness as we look into the fourth quarter around how quickly that will snap back. So there are certainly scenarios where that could do much better. But that's the primary backdrop. As we look at the rest of the portfolio, obviously, we did signal that national security and digital has had a very strong first half on margins, there's always the potential those are able to sustain at those levels.

But again, looking at some of the milestones, we pulled back a bit on that for the second half guidance. And then the last piece, Noah, what I'd point to is the investments, taking advantage of this opportunity to make sure we're funding an innovation fund that we can dial up or dial back depending upon the progress that's being made and really make sure that we've got a jump start on 2025. So the fundamentals of the business across the board are in great shape. We feel good about that.

In fact, there are some areas still on the optimization side that we still have ahead of us to get after on indirect cost management. So I feel like we're really well positioned as we look at '25.

[Thomas Bell, executive]

No, I'll just put something Chris said in his prepared remarks, and that is our 2Q profitability was aided by having 2 quarters' worth of incentives in hit in the second quarter. So the profitability of that business was enhanced because of that. The underlying business remains as solid as it ever has been.

[Noah Poponak, analyst]

Okay. And Chris, the VBA -- or I guess it sounded like you guys are saying you don't even don't have an RFP yet. It sounds like recompetes imminently without an RFP yet maybe unlikely, I don't -- is that sliding out? Does that make an extension more likely?

[Chris Cage, executive]

That's how we see it. It's been fluid. We've been rehearsing and preparing and can adapt to any scenario, but it's becoming more and more likely that there is an extension of some kind versus recompete, but we can't commit to that. We're just prepared for whatever the VA is able to do in a short order here.

[Noah Poponak, analyst]

But you still expect them to slow down the activity while that's being sorted out?

[Chris Cage, executive]

At least until they've got a new government fiscal year, and that will help them get into a new budget environment. Now they -- again, they could be aided by Congress in the near term, but our baseline assumption at this point in time as activity levels are more muted over the next few months.

[Stuart Davis, executive]

Livia, it looks like we've gone beyond the hour. So I think we'll call the Q&A at this point. So I want to thank you for your assistance on the call and thank everybody on the call today for your interest in Leidos and we look forward to catching up with you in the future. .

[Operator]

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation, and you may now disconnect.