Science Applications International - Earnings Call - Q2 2026

Executive Summary

• Q2 FY26 delivered mixed results: revenue of $1.77B fell 3% YoY and came in below consensus, but adjusted EPS of $3.63 materially beat Street expectations and margins improved on strong program execution and legal settlement benefits. Versus consensus, revenue was $1.77B vs $1.86B*, and adjusted EPS was $3.63 vs $2.24* (bold beat).
• Guidance reset: management lowered FY26 revenue to $7.25–$7.325B and adjusted EBITDA to $680–$690M, while raising adjusted EPS to $9.40–$9.60 and FCF to >$550M (derisked outlook given delays in awards and on‑contract growth).
• Bookings and backlog remain a key positive: net bookings $2.6B (book‑to‑bill 1.5), TTM book‑to‑bill 1.0, backlog ~$23.2B, funded $3.6B.
• Stock reaction catalysts: a significant EPS beat and margin expansion vs a revenue miss and lower topline/EBITDA guidance; upcoming Q3 detail on cost efficiency initiatives and the Section 174 cash tax benefits bolster FCF and could support buybacks, while the derisked revenue guide tempers near‑term growth expectations.

What Went Well and What Went Wrong

What Went Well

• Margin expansion and EPS beat: adjusted EBITDA margin rose to 10.5% (from 9.4% YoY) and adjusted EPS of $3.63 rose 77% YoY; CFO cited underlying margin of ~10.2% excluding legal settlement and state tax impacts. “Our revised guidance assumes that the operating environment remains stable but does not improve this year…we are confident in our ability to execute against it.” — CEO Toni Townes‑Whitley.
• Civilian segment outperformance: Civilian adjusted operating margin reached 13.7%, up from 11.4% YoY; adjusted operating income increased to $54M (+17% YoY) on improved profitability.
• Strong bookings/backlog and notable awards: net bookings $2.6B and backlog ~$23.2B; notable awards include HOPE 2.0 ($928M) for USAF TENCAP and $728M Treasury cloud task order, supporting future ramps.

What Went Wrong

• Revenue contraction and miss: revenue decreased 3% YoY to $1.769B on contract completions and slower ramps; fell below Street consensus of ~$1.863B*.
• Topline and EBITDA guidance cut: FY26 revenue guide lowered by ~4% vs prior ($7.60–$7.75B to $7.25–$7.325B) and adjusted EBITDA reduced to $680–$690M, reflecting delays in awards and on‑contract growth conversion.
• Free cash flow declined YoY in the quarter: FCF was $150M vs $241M YoY, impacted by MARPA Facility dynamics and working capital timing; cash from operations fell to $122M from $138M YoY.

Transcript

Speaker 7

... Good day, and thank you for standing by. Welcome to the SAIC Fiscal Year 2026 second quarter earnings conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there'll be a question-and-answer session. To ask a question during the session, you'll need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised, today's conference is being recorded. I would now like to hand the conference over to your speaker today, Joseph DeNardi, Senior Vice President, Investor Relations, and Treasurer. Please go ahead.

Speaker 3

Good morning, and thank you for joining SAIC's second quarter fiscal year 2026 earnings call. My name is Joe DeNardi, Senior Vice President of Investor Relations and Treasurer, and joining me today to discuss our business and financial results are Toni Townes-Whitley, our Chief Executive Officer, and Prabu Natarajan, our Chief Financial Officer. Today, we will discuss our results for the second quarter of fiscal year 2026 that ended August first, twenty twenty-five. Please note that we may make forward-looking statements on today's call that are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from statements made on this call. I refer you to our SEC filings for a discussion of these risks, including the risk factors section of our annual report on Form 10-K.

We may elect to update the forward-looking statements at some point in the future, but we specifically disclaim any obligation to do so. In addition, we will discuss non-GAAP financial measures and other metrics which we believe provide useful information for investors, and both our press release and supplemental financial presentation slides include reconciliations to the most comparable GAAP measures. The non-GAAP measures should be considered in addition to, and not a substitute for, financial measures in accordance with GAAP. It is now my pleasure to introduce our CEO, Toni Townes-Whitley.

Speaker 1

Thank you, Joe, and good morning to everyone on our call. Overall, our results in the quarter were mixed, with revenue below our expectations, declining 2.7% year over year, but profit margins rebounding well from the first quarter by strong program execution. In addition, we delivered a second consecutive quarter with a book-to-bill comfortably over 1.0, driving our year-to-date book-to-bill to 1.4. Our qualified pipeline, planned submit levels, and backlog of pending awards all remain strong, and we believe the investments made and business development processes implemented in recent quarters position us well to capitalize on a rich set of opportunities. As you can see from our revenue performance in the quarter and our updated outlook, we are seeing a more challenging environment than we had previously forecasted. There are three drivers behind this. First, slower conversion of on-contract growth opportunities into revenue.

Second, an increase in the impact from program disruptions, and third, delays on our new business awards. As we highlighted on our first quarter call, our prior revenue guidance for the year of 2%-4% growth assumes several points of contribution from a combination of on-contract growth and new business wins ramping up within a certain time frame. While recent new business, including TENCAP with the Air Force and a key program with the Navy, valued at approximately $350 million, will contribute modestly to this year and further ramp in fiscal year 2027. On-contract revenue growth has been impacted by funding uncertainty, added scrutiny related to efforts to reduce government spending, and a government workforce dealing with increased turnover. These headwinds have been more pronounced at customers working through particularly meaningful transformation or facing greater budget uncertainty.

As you will recall from our first quarter call, we indicated that delays in new business awards would require a greater contribution from on-contract revenue in order for us to meet our plan for the year. Based on trends we've seen in recent months, we now see that as unlikely to materialize, and we've updated our guidance for Fiscal Year 2026 and Fiscal Year 2027 accordingly. Our revised outlook for Fiscal Year 2026 revenue assumes that current trends continue through the remainder of the year, with very little contribution from additional new business or on-contract growth. While we believe that much of the revenue headwind we are facing is temporary and will normalize over time, we are taking purposeful action to align our cost structure with the more challenging revenue environment expected over the next several quarters.

As we highlighted on last year's Q3 call, our cost structure is variable, and the preparation we have taken in recent quarters positions us well to respond appropriately with cost efficiency initiatives to mitigate the impact on EBITDA and free cash flow from lower revenue. While some of these initiatives are already underway, we will discuss the specifics in greater detail on our third quarter call. The savings resulting from these initiatives give us greater confidence in our ability to continue to deliver margin improvement while investing appropriately for growth and value creation in the coming years. Given the relative magnitude of our revision to revenue, I want to be very clear that the revised outlook assumes that impacts from on-contract growth and new business award delays continue, which we believe is a prudent assumption given the current market.

As a result, we see the updated guidance range as appropriately de-risked based on our current assessment of market conditions. Now, while the current market volatility and the impact it is having on our near-term revenue is disappointing, I'm encouraged by the signs of progress we're seeing in the execution of our strategy. When I became CEO approximately two years ago, the strategy review we completed indicated that substantial changes were needed across many facets of the business in order for SAIC to regain a position of leadership and maximize long-term value for our employees, customers, and shareholders. We knew that the path towards regaining the leadership would not be linear.

While this quarter's results, revised outlook, and recent market volatility have been challenging, and we are addressing them head-on, I will draw your attention to factors that are most relevant for our success beyond this period of revenue softness and over the long term. Our year-to-date recompete win rate is in line with our target, and our planned recompetes over the next twelve months are fairly typical, with a handful of programs in the 1%-3% of revenue range. We expect to show continued progress over time in sustaining our recompete win rate at current levels. Our win rate on new business is also roughly in line with our target, as we have been successful on two of the six larger pursuits adjudicated year to date. As I indicated earlier, our pipeline of expected awards in the coming quarters remains solid.

Restoring our recompete win rates to our target range and winning our fair share of new business pursuits while increasing our submit levels, is a good formula for sustainable growth over the long term. We are encouraged by the political support to provide solid levels of funding in areas including border security, FAA modernization, and homeland missile defense. However, we expect this administration's focus on efficiency to continue and suspect that budget timelines are likely to be dynamic in the coming quarters. We remain confident that our strategy and business model position us well to adapt and win by delivering outcomes at speed for our customers. We are seeing increased opportunities to drive greater efficiency across our business as we leverage artificial intelligence for core operations. We expect this to materialize as an incremental tailwind to margins and savings for our customers in the coming years.

I want to conclude by thanking our employees for their dedication and focus. During our recent quarterly review of the business, I emphasized to our teams the importance of culture, leadership, and employee engagement as we continue to navigate a dynamic market and more challenging near-term revenue outlook. I am proud of how we've shown up for our customers and each other over the past several months. Our culture, anchored around our dedication to the mission of national security, positions us well to grow and create long-term value for all of our stakeholders. I'll now turn the call over to Prabu.

Speaker 2

Thank you, Toni, and good morning to those joining our call. Second quarter revenue declined 2.7%, driven mainly by a 3% year-over-year headwind related to Cloud One compute and store revenue, not fully offset by new business volume. The variance when compared to our first quarter growth rate and prior expectation, is primarily a lesser contribution from on-contract growth, which slowed to 3% in two Q from 8% in one Q, and a modest increase from the impact of program disruptions. Second quarter adjusted EBITDA was $185 million, resulting in an adjusted EBITDA margin of 10.5%. Results benefited from strong program execution and a favorable legal settlement, which was offset by an impact state taxes related to the One Big Beautiful Bill Act.

The underlying margin, adjusting for these two items of 10.2%, reflects improved profitability across our contract portfolio and represents an increase of 180 basis points quarter to quarter and 80 basis points year over year. Adjusted diluted earnings per share of $3.63 benefited from a favorable tax settlement and increased adjusted EBITDA in the quarter. Second quarter free cash flow improved meaningfully from first quarter to $150 million, though we continue to see some challenges related to the timing of invoice payments across a small set of contracts. As Toni indicated, we are updating our guidance for FY 2026 and FY 2027 to reflect a more challenging revenue environment.

We are lowering FY 2026 revenue to a range of $7.25 billion-$7.325 billion, representing organic contraction of 2%-3%. We expect organic revenue to decline by approximately 5.5% and 4% in 3Q and 4Q, respectively. Our revised FY 2027 revenue guidance of 0%-3% assumes a more subdued contribution from on-contract growth of 2%-3%, a modest benefit from new business, and a more typical headwind from contract transitions. Note that we will annualize the headwinds related to the NASA EAST loss and the Cloud One compute and store program in our third and fourth quarters, respectively.

FY 2026 adjusted EBITDA margin guidance is being lowered due to the one-time impact from Section 174 changes to our state and local taxes, which represents a 10 basis points headwind this year. We are reiterating our FY 2027 adjusted EBITDA margin guidance of 9.5% to 9.7%. As Toni indicated, we will look to mitigate the impact of lower revenue with cost efficiency initiatives, which increase our confidence in the year-over-year margin improvement plans we've outlined. We will update you on our Q3 and Q4 calls regarding the implementation of these plans and the potential upside to our margin targets they could drive. We are increasing our FY 2026 adjusted EPS guidance to a range of $9.40-$9.60, which benefits from the tax settlement in 2Q.

And a revised full-year effective tax rate assumption of 14%. Our revised FY 2027 EPS guidance of $9-$9.20 assumes a more normalized effective tax rate of approximately 23%. We are increasing our FY 2026 free cash flow guidance to greater than $550 million, which reflects a reduction in cash flow due to lower expected EBITDA, offset by lower cash taxes due to Section 174, and we are assuming a similar dynamic in FY 2027. We are still finalizing our planning and the relative impact on cash taxes between FY 2026, FY 2027, and FY 2028, but expect the three years combined to see a reduction in cash taxes of approximately $200 million.

We are on track to deliver nearly $12 in free cash flow per share in FY 2026 and between $13 and $14 in free cash flow per share in FY 2027, both higher than prior estimates. Our capital deployment plans over the next few years remain focused on driving long-term value for shareholders with sufficient capacity to support this with both share repurchases and capability-focused M&A. I will now turn the call over for Q&A.

Speaker 7

Thank you. Ladies and gentlemen, if you have a question or a comment at this time, please press star one, one on your telephone. If your question has been answered and you wish to remove yourself from the queue, please press star one, one again. We'll pause for a moment while we compile our Q&A roster. One moment for our first question. Our first question comes from Jonathan Siegelman with Stifel. Your line is open.

Good morning, Tony, Prabu, and Joe. Thanks for taking my question.

Speaker 1

Good morning.

The disaggregation, how you broke down the revenue outlook change is helpful. Specific to on-contract growth, can you comment a bit more on what type of work or customers you're seeing the greatest impacts, and does the loss of this mid-single digit on-contract growth represent a share shift to someone else, or a deferral of that potential work, or is this a real efficiency the government is driving? Thank you.

Yeah, let me take both the first and second part of your question. In terms of as we- so as I mentioned in the script, in some of the areas for on-contract growth where we've seen the challenge in converting that to revenue, the delays and the environmental, if you will, conditions, we've seen that in areas where there's great transformation across government, particularly in the Army, where we had the Army Transformation Initiative, which was launched earlier this year. Which represents a double-digit cut to the Army and in specific areas, some areas where SAIC is supporting in programs like S3I for us in Huntsville.

In these areas, we see a slowdown, if you will, a delay in our ability to grow and present new capabilities and opportunities to our customers, timing, switch, turnover in personnel, new processes, new norms, new reviews, and that is creating some of this delay. Other areas in some parts of the civilian space where, for example, the Department of the Treasury, where we have a large key cloud program, that too, has experienced significant delays in our ability to increase our on-contract position, and then I could offer up a couple of other programs, maybe in the Space Force arena, so we're seeing it across government. Look, is it related to a share battle with competitors versus an efficiency of the government? I would argue for the latter.

The efficiency, which in many ways, we have to acknowledge that, the government, OMB and other parts of government, GSA, have been very diligent in driving government efficiency efforts, many to the benefit of the U.S. taxpayer, and so we have to applaud many of those efforts. But the day-to-day reality on the ground is that it has caused delays, and as we navigate those delays, our ability to convert revenue from those opportunities has stalled, and hence, we have tried to show a prudent framework for how we look at the rest of the year, assuming that environment continues.

And we believe that it'll normalize over time with the next few quarters, which is why we've tried to de-risk, if you will, our guidance to you at the street, relative to assuming little to no improvement on the on-contract growth or in a change, a fundamental change in the, excuse me, in the award of new business over the next two, three quarters. So that's what's represented in our call.

Thank you.

Speaker 7

One moment for our next question. Our next question comes from Seth Seifman with JPMorgan. Your line is open.

Speaker 2

Hey, thanks very much, and good morning. I wanted to maybe follow up on that a little bit. Do you think—you know, you're talking about some changes in the customer approach here. Does that... Toni, how do you think that should affect kind of the structure of this industry over time and the number of players and, you know, what type of returns that people can expect?

Speaker 1

Yeah, let me take a first swing, and I'd like Prabu also to respond as well. Look, I think we have all acknowledged the volatility in the market over the last few quarters, with changes, a fundamental reduction in the government personnel, and I would say a disproportionate impact on government acquisition personnel, which is the channel to the private sector, and hence, delays and changes in process, escalations for approvals. I think that should be anticipated. It should have been anticipated. We've brought that forward, and I'm sure our peers have brought that to you. In terms of whether that resets the market in any structural way, I would say it would be too soon to tell.

But, B, I would suggest to you that I think all are trying to react to this new environment. And delay does not mean that we don't expect things to normalize over time. As we look into fiscal year 2027, for us, which would be in the next few quarters, we are starting to see signals of, I would say, normalization. Does anyone have a crystal ball exactly when that will convert to, you know, revenue as we've seen in the past? No. But I would say things have started to settle, and we are expecting that they will in fiscal year 2027. We're actually encouraged in some of the clarity we have on where the government is putting budget and priorities that line up with some of the investments in areas of our capability.

And we are also encouraged that we see reform of acquisition that we think will be positive for many parts of our market as well. So I don't wanna suggest to you that this is a durable effect over time, but I would suggest to you that organizations like ourselves who wanna be prudent and wanna be conservative in our view are going to try to explain and express this environment, I'd say, for the next two to four quarters. Prabu, any other thoughts you might have?

Speaker 2

Yeah. Thank you, Toni. That was perfect. Seth, on the structural question, I would sort of break this down into two components. One is sort of players in the industry. Clearly there we are seeing, you know, new entrants in the market, non-traditionals, with more commercial orientation to them. And I then would break down the other component of change being more commercial-like terms and conditions, maybe a little more expectation that contractors bear a little more risk on fixed-price programs. So I'd sort of bifurcate the structural changes, potentially underlined as, you know, being in those two buckets. You know, obviously, we've talked about the benefit of having more fixed-price in the portfolio. Our civil business is predominantly fixed-price in T&M, and obviously, we're delivering very healthy margins from that business.

So I think we are almost welcoming the change to more fixed price orientation, more outcome-based orientation to our programs. And as far as the structural change with new entrants, I think, you know, we welcome new newcomers in the industry as a mission integrator. I think we believe sincerely that the offerings from commercial vendors still will require mission integration at its core to be able to operate inside of the government environment. So we welcome the competition in the industrial base, and we are looking forward to the change. And then last footnote, I would say, we're not really seeing any significant changes in the terms and conditions yet. And therefore, I would say there's probably more rhetoric than reality right now on the expectation for terms and conditions to change dramatically.

While we're watching the change and we're navigating as best as we can in an uncertain environment, our fundamental focus is growing EBITDA and growing cash for our shareholders and remaining shareholder-friendly.

Okay. Okay, that, that's very helpful. Thanks. And, and then maybe just to follow up on that, I think during the, earlier, you, you mentioned Huntsville, and, you know, I kind of think of that as an area where, due to the, the Army Missile Command, being there, a place where we should be seeing a lot more resources, flowing into, given the, the focus on, missiles and, and missile defense. So, so is that something where you see, maybe some temporary... Is, is that more of a temporary, disruption there and, and a place where you see opportunity, over time?

Speaker 1

No, I think that's fair. I think there is a mixed reaction there temporarily, and what we have sort of guided to, we do have challenges on the day-to-day changes there. There's been quite a bit of transformation happening there, as you know, within the Army, but particularly within AMCOM or the Missile Command. But as you've also heard, Space Force moving to Huntsville, there's a lot of opportunity moving in that direction as well, and we are very well positioned, as you know, with a significant footprint there and engagement in that community. So we see upside, but I think, again, it's prudent for us to at least communicate to you that the environmental day-to-day experience is one that has challenged our ability to convert revenue from our existing contractual footprint, and we expect that to improve over time.

Obviously, we'll come back to you with any updates to guidance as we see greater improvement on our on-contract growth.

All right. Okay. Okay, that's, that's very helpful. Thank you.

Speaker 7

Moving forward, next question. Our next question comes from Toby Sommer with Truist. Your line is open.

Thank you. I was wondering if you could talk about the cost efficiency measures that you cited to allow you to get year-over-year margin expansion? And maybe speak to the tension between doing something on the cost side now when the revenue top line is sort of tepid as long as you think that's transitory and not sort of multi-year in nature. Thanks.

Speaker 1

No, I appreciate the question, and the two dimensions of the question. First, in terms of what we're doing, and then the balance that should be there that is not reactive, but actually part of that we are still committed to and continuing to invest in certain parts of our value creation for the business. You know, if I was to describe sort of broadly, I think we said in the script that we would come back to you next quarter to give some more specifics. But at this stage, I'd like to characterize, we're leveraging our enterprise operating model, which was part of our strategic input over the last two years, to really build rigor in a full-scale enterprise operating model, to accelerate the adoption of AI across our core functions.

That's really one of the areas that we think has the ability to have margin improvement, both what we can provide for our customers, but also, quite frankly, for our shareholders, and that said, we have a pretty full-scale program of how that's being rolled out across the organization, and we can give some more detail there, but it is important to suggest that that has been part of our strategy throughout. I believe the market, across the market, companies are looking at this kind of capability, and whether that be agentic or generative or various forms of AI and automation, we're building that into our core infrastructure and expect that to have some results over the next few quarters.

Again, to the extent that we can continue to do that, have that as a lever as we go forward, it gives us greater confidence that we can meet the expected EBITDA expectations of the street, if revenue continues to be compromised on the top line.

Speaker 2

Hey, Toby, the only thing I would add to that is that, you know, we the actions have begun. We are, you know, sort of on our way there. The reality is, I think, we're gonna take the rest of the year to calibrate against expectations for next year. The one area, and I want to be really clear about this, in the PowerPoint charts that we attached to the earnings release, we said there are two variables here. We don't really want to impact the submissions that we are committed to making for this year or next year. So I think if there's a bias, there's a bias towards ensuring that we don't decelerate on the submission volume, because we are continuing to put in good bids. We're winning our share of recompetes and new.

So the focus is keep that up while we get efficiencies elsewhere in the business to be able to fund and pay for that. And the reality is, that's where the focus is right now, and we are continuing to be very specific about our expectations on recompetes for margin, our expectations for new business margins, as well as execution margins. And the operating model is allowing us to spend a little more time with the program teams on generating more margin from the portfolio that we have today. And I will simply call out the civil business, that is really delivering, you know, mid- to high-13% margins now, up nearly 100 basis points year over year.

So we have some real opportunity, but what you're hearing from us is a lot of focus around where the attention should be spent and what we expect to get out of the portfolio we have, instead of hoping for a portfolio we don't have. So the focus is running the business effectively day-to-day.

I kind of wanted to ask a follow-up on a previous question with respect to industry composition, consolidation, portfolio shaping. Not just from an SAIC perspective, but broadly, this experience with DOGE and a change in the way the market has historically operated. Do you think that management teams in the industry have had enough time with it to develop action plans for sort of composing a business in a portfolio of exposures in a way that they have a direction for the longer term? Or are we still in sort of a wait-and-see and information-gathering phase?

Speaker 1

I think we see, it's a, it's a very fair question. I think I would kind of find a midpoint between your two bookends there. Have we had, have we seen some information? Has there been clarity on budget, in terms of budget priorities? Has there been indication of going commercial, commercial direct, and the type of demand signals that are being sent? I think we've seen those, and we started to collate, and I think as all companies are in this market, we've adapted to those demand signals. Where we're encouraged, I would suggest to you, is in the nature of the work we do.

When we call ourselves a mission integrator, we are encouraged when the market also acknowledges that as a need across various government agencies, as we've seen with an award we mentioned last quarter with SDA or the Space Development Agency, as part of looking for a mission integrator to help with the management of the satellite program. We've seen that in the recent requirements from the Department of Defense as they've revised their requirements process to ask for mission engineering and mission integration as the key touch point to the private sector for new capabilities being brought, and we've seen that even in the conversations with FAA, as they look to modernize what they've asked for is integration...

So in many ways, we feel like what we do and what we said we do well is showing up in demand signals across government, so that part and the prioritization of programs has become clear. To Prabu's earlier statements, there are new entrants, there is a clear signal for commercial capability, and as an integrator of commercial capability, we see that as a tailwind, not a headwind. Notwithstanding the current environment where we have some challenges in revenue conversion, we still see. I would argue, still feel bullish about the portfolio we have. To Prabu's point, being conservative in the frame of how we speak to on-contract growth and new business over the next few quarters doesn't suggest that as we start to see new signals, we can't adjust that guidance back to the street.

Speaker 2

And Toby, the only other thing I would add to that is I think DOGE and sort of the related disruptions, in fairness, I think would be a good wake-up call for industry. And I do think that there are parts of the market where if you're focused on pure labor-based services without differentiation in sort of either enterprise IT or mission IT that is hard to differentiate, you are vulnerable for recompetes. And I think that has been our experience, and I think it would be a crisis that's wasted by industry if we don't step up and change the way we go to market, approach labor-based models, and frankly, convert more of labor-based into differentiated tech offerings for our customers. And I think that is what the new entrants are promising.

Now, you know, query, can anyone new deliver at scale in the way that the traditional, I'm gonna say, players, deliver? I think to me, that's the challenge for industry, and we are determined to not waste this crisis.

Speaker 1

And the good news, I'll just add as the final catalyst, is that we started this conversation 18-24 months ago. We started in the conversion of our portfolio towards mission, differentiated mission and enterprise IT. You see our venturing has increased in all things that we've been doing commercial. So, not only is a crisis one thing you don't wanna waste, but we wanna be ahead of that in terms of not just reacting, but really driving our- and maybe accelerating parts of our strategy that we put in place, as I said, about 18-24 months ago.

Speaker 7

Thank you.

One moment for our next question. Our next question comes from Colin Canfield with Cantor Fitzgerald. Your line is open.

Hey, thank you for the question. Maybe following up with Seema's question, could the team maybe quantify the kind of the bridge for 2027 growth? So essentially like the three buckets of on-contract growth, new program growth, and efficiency headwinds. Maybe if you could break that out quantitatively, kind of how, or maybe just high level, like, what are the kind of big moving pieces, 2026 to 2027? Thank you.

Speaker 2

Yep. Hey, Colin, appreciate the question. I'll take a first crack at it here. Big picture, you know, flat to 3% is our guide, and I'm gonna try and bridge us to the midpoint of that number, about a 1.5%. I think we are generally assuming that growth will come out of backlog. So we expect to end the year with, I'm gonna say, roughly between, you know, 70% and 90% in backlog that's gonna convert into revenue next year. And I would say on top of that, we are assuming about, I'm gonna say, 1%-3% of on-contract growth, more in line with where we expect to be this year.

In other words, our baseline assumption is that, you know, things don't get worse, that they remain stable, and obviously, to the extent the on-contract growth recovers next year, then obviously there's potential for us to do better inside of that range at this point on the 3.03%. On new business, all we are sort of factoring right now are wins that we already have in our midst and that we expect to convert to revenue, and those are a couple of programs that Toni referenced in her script that have been slow to ramp this year, and we are hoping that those programs begin to ramp up.

The only other note I would make here is that, you know, since the end of the quarter, we have about another $1 billion of wins that have not cleared protest windows, so we're sort of out there. But it's another $1 billion, potentially to our bookings in Q3. So a combination of those three things, but fundamentally a, you know, clear-eyed, conservative view of, I would say, what growth looks like, with no expectation that things dramatically improve on-contract growth. Toni?

Speaker 1

Yeah, the only thing I would add there are the levers that are in place. We've tested these levers, and obviously, we've had conversations with the street about these levers. And I think, as Prabu mentioned, we have a way to understand whether this condition, this environmental condition, is changing and when we can make any changes to update this guidance. When I look at our underlying levers for book-to-bill, obviously, we feel good about where we are this year. We had mentioned one point two by H1. We still see line of sight to that within this fiscal year. Our submit's holding and sustaining.

Our win rate's at target for both recompete and new business, which was a question we had, I would say a couple of years ago, that we feel good that we've turned that corner, and a pending award backlog that still hovers at the $20 billion. I think those are the levers that are there that suggest that when we can address the delay environment, we have enough in the kitty, if you will, to start to drive to within the range we've offered, as well as hopefully be able to improve upon it.

Got it. Thank you. And then maybe focusing on leverage, appreciate the kind of, commentary in the, your presentation around lead times. But you've, you've gone above that in the past, and obviously shares are off today. And, like, given the kind of Section 174 benefits, I think it's like a 14% free cash flow yield on, on 27 free cash flow per share. So how do you think about going above three times net debt to EBITDA to do, you know, something like, an accelerated share repurchase or, or more repo?

Speaker 2

Yeah. Hey, Colin, fair question. I mean, look, I think what we've signaled in the past is targets above three, but we don't mind being a little bit over or a little bit under three times. Obviously, you know, we approach our share repurchases with a grid in place, and we get to update the grid as we go forward. To the extent you know, price reacts negatively, we have the capacity to buy more shares. So fundamentally, no change to capital deployment. I think given the compression we've seen in our EBITDA, I think it's only fair to ensure that we don't run leverage up to a place where we are not comfortable in an uncertain environment. So I think that's the balance.

But I would say big picture, you know, we're on our way to buying between $350 and $400 this year, and we'll probably end up retiring more shares at these prices than what we previously contemplated, but I'm cognizant of leverage.

Got it. And just maybe one more. A lot of focus on efficiency on this call, but I think it's, you know, probably worth differentiating between, like, what I would call one-half calendar efficiencies, which is, you know, folks ripping up contracts or trying to rip up contracts and then posting it on Twitter. And then kind of second half efficiencies, which is, you know, government officials trying to kind of shape the FY 2026 budget process, and that's taking some kind of slowness dynamics that are, you know, that come with new administration. So maybe just digging into it, can you maybe differentiate how much of the efficiency dynamics you're seeing are called what we would call kind of, you know, one-half disruptive efficiencies or more kind of second half FY 2026, FY 2027 shaping efficiencies? Thank you.

Yeah, I'm gonna maybe try, take a first crack at this. I would say by and large, the disruptions have been to our current fiscal year. We are expecting that the flavor of the disruptions probably continue into the end of the year for us, at the end of our fiscal year. But I would say, if not yet, disruptions that we believe are about FY 2027. So more of a 2026 flavor to it, which is why I think we are of the view at this point that the environment is stable, though we would love for it to improve. That has not actually happened, and the trades that our customers are making, frankly, are trades with respect to the current government fiscal year that ends at the end of September.

Our expectation is that we're gonna be in a CR to start the new fiscal year. I think that's our assumption, but it's mostly twenty-six focused.

Speaker 1

Yeah. I would say I agree on the 2026 and would suggest that don't see improvements, also don't see a decline. When we say stable, this is why we're holding to, again, a prudent view of 2026 and carried into 2027 in terms of what this stability and, quite frankly, some of the signals on the ground for efficiency, and I wanna make sure when we speak to that, while it has had volatility on our day-to-day with our customers, we do see progress the government is making towards overall increases in efficiency across the various agencies. And we're partnered with the government to that outcome.

Got it. Thank you for the color. I appreciate the multiple questions. Thanks.

Speaker 2

You bet.

Speaker 7

One moment for our next question. Our next question comes from Gautam Khanna with Cowen. Your line is open.

Thanks. Good morning, guys.

Speaker 1

Good morning, Gautam.

Two questions. One, I was just curious if you could frame what your expectations are for the government fiscal year-end flush, if we have one. And then secondly, if you could speak to exposure and your contingencies, if we do go into a shutdown of some protracted length, call it a month or two, how would that show up, and how would that impact the PNL? Thanks.

Yeah. Let me. I'll take the first part of that on the flush environment and have Prabu speak to expectations relative to, or contingencies relative to a CR environment. Look, I think we all talk about sweeps and flush at the end of a government fiscal year. I would suggest to you that it has been irregular relative to prior fiscal years, given the Reconciliation Act and all that has happened with budget reconciliation. In many ways, what might have been a flush environment might portend increasing on-contract growth for various organizations have actually gone in very specific line items relative to reconciliation. And so we have not seen a significant opportunity in that environment towards the end here of the government fiscal year. Relative to the CR, Prabu, you wanna highlight?

Speaker 2

Yeah, Gautam, fair question. I think, you know, we have a few different precedents over the last, you know, handful of years, and I would say the longest was, if I recall, 38 or 39 days, and the revenue impact that year was a little less than 1% for a full month, if you will. And, you know, I think query, if that scenario plays out, would you be able to recover that in the fiscal year? I think our assumption is we're gonna have a CR at year-end, and to the extent it, we end up with a shutdown, that's lengthy, then, certainly we'll have to talk about it on the December call. But CR is our base case.

There was an impact to cash, but generally, cash tends to recover within a couple of billing cycles, so I would not really expect a material impact to cash. So I would say, you know, marginal impact on revenues and probably little to no impact on cash if it's a traditional shutdown, if you will.

Thank you.

Speaker 7

One moment for our next question. Our next question comes from Gavin Parsons with UBS. Your line is open.

Morning, this is Max Miller on for Gavin.

Speaker 1

Good morning, Max.

A two-part question for you. A, has there been an incremental change in the customer's attitude towards procurement over the past ninety days, specifically, that led you to revisit the guide? And then, B, you know, looking forward, it's clear you expect the back half to be stable but not necessarily improve. What would it take for you to become more constructive on the outlook and that recovery and on-contract growth? It sounds like there are some, you know, signals of normalization that you're already seeing.

Yeah, fair questions. I think on the front end was the question about on-contract growth. Actually, remind me of the first question. I'm sorry. Come back one more time on your first part of your question.

Just if there's been an incremental change in the past ninety days, specifically, that led you guys to-

Got it.

Revisit the guidance.

Yeah. Yeah. I wouldn't, I wouldn't say an incremental change over the last ninety days. I think we started in the last quarter speaking to a roughly 1% impact on program cuts and that we could track that, and we're still tracking to something in that range in terms of program cuts. I think what we started to see in the environment was the effect of delay. Delay in our interaction with our customers, our ability to add to our current contract footprint. So on-contract growth was the first sort of big signal for us that we were gonna have revenue compression. We also had mentioned in our first quarter earnings call that our guide and our call were gonna be particularly dependent on new business landing in a specific timeframe.

And we still see delays in that new business, as you can see in our pending award backlog. Third, I think we also mentioned and have seen now slow in the ramp of new business that we have won. And so we mentioned a program like TENCAP and others, where we have new business wins, we assume a ramp on that, and those ramps have also been slower. So those three indicators, I think, are what we've seen that have adjusted our revenue guide. Would I say they all came to fore in the last ninety days? No, I think some of the root causes were there, but we started to show they started to show up across our various programs, and so we felt it prudent to obviously address that.

I think the second part of your question was, what would it take? What would be the indicators in the second half and/or as we look forward to adjust guidance in a more constructive manner? Look, I think it's the same. The same indicators are there. On-contract growth and the engagement that we have with our customers, our ability to convert to revenue on existing contracts, will be a very significant indicator for us. Improvements in that environment, improvements on the timing and the conversion of that revenue, would be an indicator on a direction up. On new business award, getting awards actually adjudicated. We always put in some understanding of some timeline relative to protests, given our protest environment.

But even with that, getting awards actually adjudicated would be, and again, assuming that win rates hold as we've seen at target level, that would portend that we would have potential upside to the guidance that we've offered. Getting those awards adjudicated, and then, quite frankly, the third would be being able to increase our ramp and our velocity on existing programs that are new, and we've mentioned a couple of those. Those will be the indicators that help us understand if we can, if you will, improve upon the guide that we've offered.

Got it. That makes sense. Thank you. And then for 2027, it sounds like the base assumption is that the funding environment is mostly similar to this year. Is there any assumption that it improves, you know, later on in the year, or is the assumption right now that it's similar for the majority of 2027?

Speaker 2

There's probably, Max, a glide path here where, you know, the latter half of 2027 probably does improve if we are in a CR. I think that's just math would tell you that it has to improve. I think our baseline assumption, I don't want to get into the cadence of providing quarterly just yet for FY 2027. We'll do that on the December call. But I do expect that, you know, the second half of 2027 will be smoother than the first half of 2027, but that is with the health warning that we don't know everything we need to know in order to provide that guidance crisply.

Got it. Thank you very much.

Speaker 7

One moment for our next question. Our next question comes from David Strauss with Barclays. Your line is open.

Thanks, Maureen.

Speaker 2

Hey, David.

Speaker 1

Good morning, David.

Just wanted to ask about the, the cautious cost efficiency measure you're contemplating. I, I wasn't clear, but I think you're saying that those are not contemplated in your updated EBITDA margin, EBITDA guidance. Is that correct, that you haven't actually included those, those potential cost efficiencies?

Speaker 2

That is correct, David.

Okay. And then if you look at your sales relative to your large peers, I mean, certainly some of your large peers have highlighted impact from DOGE and budgets and all the things that you're saying today. But it looks like you're seeing a larger relative impact. What would you attribute that to? I mean, I know there are, you know, business mix plays into this, but, you know, what would you attribute the, you know, the extent of the impact you're seeing relative to your peers?

Speaker 1

I would really call out a couple of things. First, I think as we talk about on-contract growth, that is particularly program-based. Where we have footprint with specific customers on specific programs, and we've mentioned, I think I mentioned in the earlier script, that where we see large transformation occurring or where there's great budget uncertainty, we see a higher correlation of the on-contract growth environment being more challenged. We could compare footprint to footprint, but I think it is more meaningful and profound to suggest that the market is experiencing some of these delays, and where we see the greater challenge is where our customers are, quite frankly, in the highest volatility. As you talk about new business awards, I think, again, the entire market is experiencing some delays on the new business awards.

We have some large awards, and we see a larger, a longer delay relative to large transformative awards. And so to the extent that that populates your pipeline, I think you're going to experience that maybe disproportionately. So I would suggest you program ramp. I don't think that is particularly unique for us as well on new programs. But to the extent that we are, I think, also trying to, as we have, I think historically, give a very unvarnished position, a fairly prudent position on what we think the environmental conditions are, how long we think they will be in place, and the impact that they're having, I think that is probably, you know, how I would take away how we are communicating versus or in relation to some of our peers.

Okay, and my last question. On the recompete side, I think you mentioned that you have a number of recompetes kind of in the 1%-3% range. Could you just size, you know, what your total recompete, you know, the recompete bucket is in fiscal 2026 and fiscal 2027, and what you've kind of assumed within that in terms of recompete win rates, you know, that's baked into your revenue guide for both years?

Speaker 2

David, I'll take that one. In terms of maybe I'll start with the second part of the first. In terms of our assumptions around recompete, we would say, you know, if you think about it, 80%-90% would be a pretty good recompete win rate for next year, and new business, we would say 30%-40%. That's probably the going-in assumption right now. In terms of what is specifically factored in, you know, we traditionally don't get into the eaches on the recompete, so that's why we've sort of called it out as, you know, a handful of programs that are in the 1%-3% range, which is pretty normal. If I had to zoom out a little, I would say 10%-15%, which is typically our run rate.

I would note that our recompete win rates have, you know, stabilized pretty significantly in the last couple of years, and we are back to what is assumed to be a traditional industry standard of about 90%. And as we sit here, the only known headwind is AFIMS, which is the Air Force where we had a pre-award protest a couple of months ago. That is the only known recompete headwind, because NASA EAST laps out at Q3, and Cloud One, where we walked away, frankly, from you know going after that program, that also laps out of about Q4. So only one known program right now that is probably worth about 0.5% to 1% for next year, but that is really the only known headwind.

Speaker 1

Vanguard is just-

Speaker 2

And Vanguard has been extended for a couple of years. So, so I, I'd say it looks cleaner than it has looked in the last couple of years.

Great. Thanks very much.

Speaker 7

One moment before our next question. Our next question comes from Noah Poponak with Goldman Sachs. Your line is open.

Hey, good morning, everyone.

Speaker 1

Good morning, Noah.

Hopefully you can hear me okay. I have a little background music where I am. But, you know, I guess this has sort of been asked a little bit, but the biggest question for me is just duration of what's happening in your end markets, and is it temporary or is it structural and multi-year or something in between? And I guess, it seems like the customer is clearly wanting to go through a major reprioritization across government spending within DOD, within FedSIV, whether that's DOGE, the 2026 request, the DOD memos. Tony, you gave an example of programs actually being reduced in size, you know, not just delayed. Government moves slow. Other spending downturns historically can be fairly long.

I guess I'm a little surprised that you're still referencing this as delays and timing and change in administration. And ultimately, I guess the question is, when you're providing multi-year financial outlook, and maybe more importantly, how you manage the business and cost and its structural size, how are you thinking about and debating internally this being a three- to five-year structural shift versus a three- to five-quarter temporary issue?

... I think it's a fair question. Let me go back to where I started the conversation earlier on this call. The strategy that we put forward involved the shifting of our portfolio towards enterprise and mission IT. And that was prior to an administration change, the belief that we needed to move to more differentiated capability in stickier revenue and longer term and more mission-critical environments, and quite frankly, to integrate more commercial technology and introduce more commercial technology into those mission environments. That was in place, and in many ways, that continues. There's no signal that we've seen from the current administration that would suggest that that strategy is the wrong one. In fact, if anything, we've probably had to accelerate that.

The other part of our strategy was getting our own go-to-market in place with a business development engine that is, I would argue, delivering at least on the key, getting us back to target on win rate, increasing our submissions, improving the accretive nature of our recompete bids, and being able to sustain a pending award backlog, so the elements of the business, both the go-to-market as well as our portfolio, I would argue there is nothing structurally that should fundamentally change, if not just accelerate. We've got a temporal, what we would argue to be a temporal condition relative to how we engage with customers on contract growth, delays, and how we adapt to an environment that has delays and new changes and new norms, then Prabu spoke to the conversation of the demand signal.

How are we listening to the demand signal for direct commercial, COTS, commercial business models, as well as commercial tech being brought? How do we go into more SaaS offerings or share-in-savings offerings, or again, more commercial? So we are absolutely accelerating those capabilities, fixed-price and outcome-based contracting, our ability to deliver. We've had a very solid track record in fixed-price and T&M contracts and our ability to deliver that. So I would argue that in many ways, we are taking the strategy we had and accelerating it in this environment. We are making more bets on the venture side, we are partnering with non-traditional defense contractors, and we are highlighting mission integration in an open environment with investments in mission labs and the ability to do end-to-end integration with more and more commercial tech.

The strategy itself is a multidimensional strategy that would suggest we've got to have, in the short term, the ability to, if you will, bridge this current environment, which is challenging for us, and we are doing that both in terms of looking at AI adoption across and other ways that we make sure that we contain and hold our cost structure in place. As well, we are also making sure we continue to invest in the differentiation, as Prabu spoke to in terms of IT and other capabilities, and disrupting, in some ways, our own labor model, which we believe is going to be a challenge going forward, in terms of a market that will look for more product-like capability. All of that was sort of envisioned in the strategy.

In many ways, we are accelerating that in this current environment, and we see in setting some targets for the future. I would argue that as we move into the second horizon of this strategy, we actually will be lined up with where supply and demand should hopefully intersect in what we built and what the government is asking for. So I would say this is, that this environment has forced, if anything, has forced us to accelerate our strategy and has forced us to further clarify our efforts and create more levers, if you will, to offset in a revenue-tight environment, to offset by holding to our cost structure.

Speaker 2

Toni, if I might add to that.

Speaker 1

Yeah.

Speaker 2

You know, the assumption on, you know, how we operate the business, I think the budget assumption would be that it's going to be a difficult budget environment, and flat to low single digits would be, you know, probably a reasonable assumption. It's probably not a perfect assumption, and that even within the flat to low single digit growth rate, there will be efforts to reprioritize where the budget dollars go. That is the baseline budget assumption. As far as the how we manage the business question, I think we have to assume that things get worse before they get better, and part of the focus that Toni's brought to the team around AI, around a better execution, is really to ensure that we are staying ahead of whatever revenue compression we see in the market.

That means committed to delivering EBITDA dollar growth consistently to The Street, which is why we're holding our guide right now for next year at 9.5-9.7. So our focus is assuming that the disruption continues for longer than three to five quarters, how would you manage this business? And that's the conversation we're having, and those are the plans we're making. And importantly, part of the plans will be to see where is the greatest source of compression inside of the portfolio relative to the next two to three years. And as Toni rightly said, labor-based models will be disrupted, maybe not linearly, but in some fashion, they will be disrupted.

I think part of our effort is to essentially ensure that we can, you know, so if you will, cannibalize our own labor base to ensure we are delivering more differentiation, hence more value, and hence more earnings and cash for our shareholders. That's how we're thinking about operating the business and planning towards.

I really appreciate the thoughtful and detailed answer there. Prabu, just one more. Can you break out for 2026 and 2027 EPS and free cash flow guidance? For each of those four, what's the change in the net income versus what's the change in tax? Sorry, I should say net income from the business pre-tax.

Yeah. So I'll give you the components of it. Noah, and Joe can certainly give you a little more detail for our FY 2027. I think the way we're thinking about the updated 2027 guide is, you know, we are going to see a reduction in top line relative to our prior assumption, which is going to lower the EBITDA we generate from the business, and think of that as a $30-$40 million reduction to cash. And then offset by Section 174, which is a $110 million offset for next year. So the net change is an increase to free cash flow to about $600 million, which is our current expectation for free cash flow in FY 2027.

Similar dynamic for 2026, where we are lowering the EBITDA dollars generated from the business, but offsetting it with, I would say, implied $60 million of cash tax benefit from Section 174. And right now, the big change on EPS between 2026 and 2027 is that this year we are going to benefit from an incredibly low tax rate of about 14%, hence the, you know, $9 change guide for this year. Next year, our current assumption is, though I will have immense confidence in our tax team, our current assumption is 23% for next year, and every point on the tax rate is worth about 10 cents. It's a dime. So 9% change to the tax rate is worth nearly a buck in EPS.

So if we delivered the same tax rate next year as we did this year, we'd be $1 higher on EPS. Stated differently, if this year were more like next year, we'd be $1 lower.

That is super, super helpful. And the cash tax reversal that you get in 2027, do you hold that for a while, or does that decline over time, or what happens to that over time?

Yeah. So we expect big picture to get back about, let's call it $200 million, a little over $200 million, which is the Section 174 taxes we've paid up over the last three years. Our current expectation, as we prefaced on the call, is that we'll get about, you know, $60 million back this year, another $110 million back next year, and Matt would suggest we should get a little more back in 2028. And then we'd have to come back to you, and we'll update for 2028 a little bit later in the year. But I think a normal run rate for free cash flow, you should think of that as being in that $530-$540 million range for FY 2028. So kind of more normalized.

Okay. I really appreciate all the detail. Thank you.

Sure.

Speaker 7

I'm not showing any further questions at this time, and as such, this does conclude today's presentation. You may now disconnect and have a wonderful day.