Leidos Holdings, Inc. 10-Q

Item 1. Financial Statements. LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) October 1, 2021 January 1, 2021 (in millions) Assets: Cash and cash equivalents $ 587 $ 524 Receivables, net 2,288 2,137 Inventory, net 268 276 Other current assets 426 402 Total current assets 3,569 3,339 Property, plant and equipment, net 662 604 Intangible assets, net 1,321 1,216 Goodwill 6,650 6,313 Operating lease right-of-use assets, net 638 581 Other assets 441 458 Total assets $ 13,281 $ 12,511 Liabilities: Accounts payable and accrued liabilities $ 2,142 $ 2,175 Accrued payroll and employee benefits 721 632 Short-term debt and current portion of long-term debt 484 100 Total current liabilities 3,347 2,907 Long-term debt, net of current portion 4,616 4,644 Operating lease liabilities 615 564 Deferred tax liabilities 254 234 Other long-term liabilities 283 291 Total liabilities 9,115 8,640 Commitments and contingencies (Note 10) Stockholders’ equity: Common stock, $ 0.0001 par value, 500 million shares authorized, 140 million and 142 million shares issued and outstanding at October 1, 2021 and January 1, 2021, respectively — — Additional paid-in capital 2,397 2,580 Retained earnings 1,758 1,328 Accumulated other comprehensive loss ( 40 ) ( 46 ) Total Leidos stockholders’ equity 4,115 3,862 Non-controlling interest 51 9 Total stockholders' equity 4,166 3,871 Total liabilities and stockholders' equity $ 13,281 $ 12,511 See accompanying notes to condensed consolidated financial statements. 1 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended Nine Months Ended October 1, 2021 October 2, 2020 October 1, 2021 October 2, 2020 (in millions, except per share amounts) Revenues $ 3,483 $ 3,242 $ 10,246 $ 9,045 Cost of revenues 2,942 2,774 8,740 7,799 Selling, general and administrative expenses 233 200 625 583 Bad debt expense and recoveries ( 1 ) 2 ( 11 ) ( 70 ) Acquisition, integration and restructuring costs 6 5 21 33 Asset impairment charges 3 — 3 11 Equity (earnings) loss of non-consolidated subsidiaries ( 5 ) 3 ( 14 ) ( 10 ) Operating income 305 258 882 699 Non-operating expense: Interest expense, net ( 47 ) ( 44 ) ( 138 ) ( 133 ) Other income (expense), net 2 — 1 ( 30 ) Income before income taxes 260 214 745 536 Income tax expense ( 52 ) ( 51 ) ( 162 ) ( 104 ) Net income $ 208 $ 163 $ 583 $ 432 Less: net income attributable to non-controlling interest 3 — 4 1 Net income attributable to Leidos common stockholders $ 205 $ 163 $ 579 $ 431 Earnings per share: Basic $ 1.45 $ 1.15 $ 4.11 $ 3.04 Diluted 1.43 1.13 4.05 2.99 See accompanying notes to condensed consolidated financial statements. 2 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) Three Months Ended Nine Months Ended October 1, 2021 October 2, 2020 October 1, 2021 October 2, 2020 (in millions) Net income $ 208 $ 163 $ 583 $ 432 Foreign currency translation adjustments ( 29 ) 26 ( 12 ) 13 Unrecognized gain (loss) on derivative instruments 4 4 18 ( 41 ) Pension adjustments — ( 1 ) — — Total other comprehensive (loss) income, net of taxes ( 25 ) 29 6 ( 28 ) Comprehensive income 183 192 589 404 Less: net income attributable to non-controlling interest 3 — 4 1 Comprehensive income attributable to Leidos common stockholders $ 180 $ 192 $ 585 $ 403 See accompanying notes to condensed consolidated financial statements. 3 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED) Shares of common stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Leidos Holdings, Inc. stockholders' equity Non-controlling interest Total (in millions, except for per share amounts) Balance at January 1, 2021 142 $ 2,580 $ 1,328 $ ( 46 ) $ 3,862 $ 9 $ 3,871 Net income — — 205 — 205 — 205 Other comprehensive income, net of taxes — — — 9 9 — 9 Issuances of stock — 14 — — 14 — 14 Repurchases of stock and other ( 1 ) ( 123 ) — — ( 123 ) — ( 123 ) Dividends of $ 0.34 per share — — ( 49 ) — ( 49 ) — ( 49 ) Stock-based compensation — 15 — — 15 — 15 Capital contributions from non-controlling interests — — — — — 38 38 Balance at April 2, 2021 141 2,486 1,484 ( 37 ) 3,933 47 3,980 Net income — — 169 — 169 1 170 Other comprehensive income, net of taxes — — — 22 22 — 22 Issuances of stock 1 9 — — 9 — 9 Repurchases of stock and other — ( 3 ) — — ( 3 ) — ( 3 ) Dividends of $ 0.34 per share — — ( 48 ) — ( 48 ) — ( 48 ) Stock-based compensation — 17 — — 17 — 17 Net capital contributions from non-controlling interests — — — — — 1 1 Balance at July 2, 2021 142 2,509 1,605 ( 15 ) 4,099 49 4,148 Net income — — 205 — 205 3 208 Other comprehensive loss, net of taxes — — — ( 25 ) ( 25 ) — ( 25 ) Issuances of stock — 11 — — 11 — 11 Repurchases of stock and other ( 2 ) ( 140 ) — — ( 140 ) — ( 140 ) Dividends of $ 0.36 per share — — ( 52 ) — ( 52 ) — ( 52 ) Stock-based compensation — 17 — — 17 — 17 Net capital contributions to non-controlling interest — — — — — ( 1 ) ( 1 ) Balance at October 1, 2021 140 $ 2,397 $ 1,758 $ ( 40 ) $ 4,115 $ 51 $ 4,166 See accompanying notes to condensed consolidated financial statements. 4 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED) Shares of common stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Leidos Holdings, Inc. stockholders' equity Non-controlling interest Total (in millions, except for per share amounts) Balance at January 3, 2020 141 $ 2,587 $ 896 $ ( 70 ) $ 3,413 $ 4 $ 3,417 Cumulative adjustments related to ASU adoption — — ( 1 ) — ( 1 ) — ( 1 ) Balance at January 4, 2020 141 2,587 895 ( 70 ) 3,412 4 3,416 Net income — — 115 — 115 — 115 Other comprehensive loss, net of taxes — — — ( 115 ) ( 115 ) — ( 115 ) Issuances of stock 1 9 — — 9 — 9 Repurchases of stock and other — ( 32 ) — — ( 32 ) — ( 32 ) Dividends of $ 0.34 per share — — ( 49 ) — ( 49 ) — ( 49 ) Stock-based compensation — 15 — — 15 — 15 Balance at April 3, 2020 142 2,579 961 ( 185 ) 3,355 4 3,359 Net income — — 153 — 153 1 154 Other comprehensive loss, net of taxes — — — 58 58 — 58 Issuances of stock — 8 — — 8 — 8 Repurchases of stock and other — ( 2 ) — — ( 2 ) — ( 2 ) Dividends of $ 0.34 per share — — ( 49 ) — ( 49 ) — ( 49 ) Stock-based compensation — 15 — — 15 — 15 Capital contributions from non-controlling interests — — — — — 4 4 Balance at July 3, 2020 142 2,600 1,065 ( 127 ) 3,538 9 3,547 Net income — — 163 — 163 — 163 Other comprehensive income, net of taxes — — — 29 29 — 29 Issuances of stock — 10 — — 10 — 10 Repurchases of stock and other — ( 1 ) — — ( 1 ) — ( 1 ) Dividends of $ 0.34 per share — — ( 48 ) — ( 48 ) — ( 48 ) Stock-based compensation — 15 — — 15 — 15 Balance at October 2, 2020 142 $ 2,624 $ 1,180 $ ( 98 ) $ 3,706 $ 9 $ 3,715 See accompanying notes to condensed consolidated financial statements. 5 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended October 1, 2021 October 2, 2020 (in millions) Cash flows from operations: Net income $ 583 $ 432 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization 244 214 Stock-based compensation 49 45 Loss on debt extinguishment — 31 Asset impairment charges 3 11 Deferred income taxes 4 ( 2 ) Other ( 11 ) 15 Change in assets and liabilities, net of effects of acquisitions: Receivables ( 103 ) 140 Other current assets and other long-term assets 161 49 Accounts payable and accrued liabilities and other long-term liabilities ( 172 ) 211 Accrued payroll and employee benefits 83 247 Income taxes receivable/payable ( 20 ) ( 7 ) Net cash provided by operating activities 821 1,386 Cash flows from investing activities: Acquisition of businesses, net of cash acquired ( 622 ) ( 2,610 ) Payments for property, equipment and software ( 71 ) ( 120 ) Net proceeds from sale of assets — 10 Other — 6 Net cash used in investing activities ( 693 ) ( 2,714 ) Cash flows from financing activities: Proceeds from debt issuance 380 6,225 Payments of long-term debt ( 80 ) ( 4,680 ) Payments for debt issuance costs — ( 39 ) Dividend payments ( 149 ) ( 148 ) Repurchases of stock and other ( 266 ) ( 35 ) Capital distributions to non-controlling interests ( 3 ) — Capital contributions from non-controlling interests 41 4 Proceeds from issuances of stock 33 26 Net cash (used in) provided by financing activities ( 44 ) 1,353 Net increase in cash, cash equivalents and restricted cash 84 25 Cash, cash equivalents and restricted cash at beginning of period 687 717 Cash, cash equivalents and restricted cash at end of period 771 742 Less: restricted cash at end of period 184 230 Cash and cash equivalents at end of period $ 587 $ 512 Supplementary cash flow information: Cash paid for income taxes, net of refunds $ 179 $ 110 Cash paid for interest 128 104 Non-cash investing activity: Property, plant and equipment additions $ 1 $ 16 Non-cash financing activity: Finance lease obligations $ 50 $ 12 See accompanying notes to condensed consolidated financial statements. 6 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1–Basis of Presentation and Summary of Significant Accounting Policies Nature of Operations and Basis of Presentation Leidos Holdings, Inc. ("Leidos"), a Delaware corporation, is a holding company whose direct 100%-owned subsidiary and principal operating company is Leidos, Inc. Leidos is a FORTUNE 500 ® science, engineering and information technology company that provides services and solutions in the defense, intelligence, civil and health markets, both domestically and internationally. Leidos' customers include the U.S. Department of Defense ("DoD"), the U.S. Intelligence Community, the U.S. Department of Homeland Security, the Federal Aviation Administration, the Department of Veterans Affairs and many other U.S. civilian, state and local government agencies as well as foreign government agencies. Unless indicated otherwise, references to "we," "us" and "our" refer collectively to Leidos Holdings, Inc. and its consolidated subsidiaries. We operate in three reportable segments: Defense Solutions, Civil and Health. Additionally, we separately present the unallocable costs associated with corporate functions as Corporate. We have a controlling interest in Mission Support Alliance, LLC ("MSA"), a joint venture with Centerra Group, LLC. We also have a controlling interest in Hanford Mission Integration Solutions, LLC ("HMIS"), the legal entity for the follow-on contract to MSA's contract and a joint venture with Centerra Group, LLC and Parsons Government Services, Inc. The financial results for MSA and HMIS are consolidated into our unaudited condensed consolidated financial statements. The unaudited condensed consolidated financial statements also include the balances of all voting interest entities in which Leidos has a controlling voting interest ("subsidiaries") and a variable interest entity ("VIE") in which Leidos is the primary beneficiary. The consolidated balances of the VIE are not material to the unaudited condensed consolidated financial statements for the periods presented. Intercompany accounts and transactions between consolidated companies have been eliminated in consolidation. The accompanying unaudited condensed financial information has been prepared in accordance with the rules of the U.S. Securities and Exchange Commission and accounting principles generally accepted in the United States of America ("GAAP"). Certain disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Management evaluates these estimates and assumptions on an ongoing basis, including those relating to estimated profitability of long-term contracts, indirect billing rates, allowances for doubtful accounts, inventories, right-of-use assets and lease liabilities, fair value and impairment of intangible assets and goodwill, income taxes, stock-based compensation expense and contingencies. These estimates have been prepared by management on the basis of the most current and best available information; however, actual results could differ materially from those estimates. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which consist of normal recurring adjustments, necessary for a fair presentation thereof. The results reported in these unaudited condensed consolidated financial statements are not necessarily indicative of the results that may be expected for the entire year. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K filed on February 23, 2021. 7 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Accounting Standards Updates ("ASU") Adopted ASU 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity's Own Equity (Subtopic 815-40) In August 2020, the Financial Accounting Standards Board ("FASB") issued ASU 2020-06 which simplifies the accounting for convertible debt and convertible preferred stock by removing the requirements to separate embedded conversion features from the host convertible instruments. Additionally, the amendments in this update simplify the guidance in Subtopic 815-40 by removing certain criteria that must be satisfied in order to classify a contract as equity. This update also improves the consistency of earnings per share calculations by requiring an entity to use the if-converted method of calculating diluted earnings per share rather than the treasury stock method for convertible instruments and also by requiring the inclusion of the potential effect of shares settled in cash or shares in the diluted earnings per share calculation. The amendments in this update are effective for public entities for fiscal years beginning after December 15, 2021, and adopted using either a fully or modified retrospective approach. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020. Entities should adopt the guidance as of the beginning of the fiscal year of adoption and cannot adopt the guidance in an interim reporting period. Effective January 2, 2021, we adopted the requirements of ASU 2020-06 using the modified retrospective method. The adoption did not have an impact to our financial position, results of operations and earnings per share. ASU 2021-05, Leases (Topic 842) Lessors—Certain Leases with Variable Lease Payments In July 2021, the FASB issued ASU 2021-05, which amends lessor’s accounting for leases with variable lease payments classified as sales-type or direct financing leases. The amendments in this update modify the lease classification requirements for lessors, whereby leases with variable lease payments that are not dependent on a reference index or a rate will be accounted for as operating leases if classification as a sales-type or direct financing lease would have resulted in a day-one loss. The amendments in this update are effective for public entities for fiscal years beginning after December 15, 2021, as well as interim periods within those fiscal years, and can be adopted using either a prospective or retrospective approach. Early adoption is also permitted. Effective July 3, 2021, we adopted the requirements of ASU 2021-05 using the prospective method. The adoption did not have an impact to our financial position, results of operations and earnings per share. Accounting Standards Updates Issued But Not Yet Adopted ASU 2020-04 and ASU 2021-01, Reference Rate Reform (Topic 848) In March 2020, the FASB issued ASU 2020-04 which provides companies with optional expedients and exceptions to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. This update provides optional expedients for applying accounting guidance to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate ("LIBOR") or another reference rate expected to be discontinued because of the reference rate reform. The amendments in this update are effective for all entities as of March 2020 and can be adopted using a prospective approach no later than December 31, 2022. In January 2021, the FASB issued ASU 2021-01 which amends the scope of ASU 2020-04. The amendments in this update are elective and provide optional relief for entities with hedge accounting and contract modifications affected by the discounting transition through December 31, 2022. Under this relief, entities may continue to account for contract modifications as a continuation of the existing contract and the continuation of the hedge accounting arrangement. We are currently evaluating the impacts of reference rate reform. We currently use the one-month LIBOR for which the rate publication will cease in June 2023. Changes in Estimates on Contracts Changes in estimates related to contracts accounted for using the cost-to-cost method of accounting are recognized in the period in which such changes are made for the inception-to-date effect of the changes, with the exception of contracts acquired through a business combination, where the adjustment is made for the period commencing from the date of acquisition. 8 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Changes in estimates on contracts were as follows: Three Months Ended Nine Months Ended October 1, 2021 October 2, 2020 October 1, 2021 October 2, 2020 (in millions, except per share amounts) Favorable impact $ 47 34 $ 115 $ 86 Unfavorable impact ( 24 ) ( 19 ) ( 72 ) ( 45 ) Net impact to income before income taxes $ 23 $ 15 $ 43 $ 41 Impact on diluted EPS attributable to Leidos common stockholders $ 0.12 $ 0.07 $ 0.22 $ 0.21 The impact on diluted earnings per share ("EPS") attributable to Leidos common stockholders is calculated using the statutory tax rate. Revenue Recognized from Prior Obligations Revenue recognized from performance obligations satisfied in previous periods was $ 17 million and $ 35 million for the three and nine months ended October 1, 2021, respectively, and $ 10 million and $ 42 million for the three and nine months ended October 2, 2020, respectively. The changes primarily related to revisions of variable consideration including award and incentive fees, and revisions to estimates at completion resulting from changes in contract scope, mitigation of contract risks or true-ups of contract estimates at the end of contract performance. Cash and Cash Equivalents Our cash equivalents are primarily comprised of investments in several large institutional money market accounts, with original maturity of three months or less. At October 1, 2021 and January 1, 2021, $ 180 million and $ 237 million, respectively, of outstanding payments were included within "Cash and cash equivalents" and "Accounts payable and accrued liabilities" correspondingly on the condensed consolidated balance sheets. Restricted Cash We have restricted cash balances, primarily representing advances from customers that are restricted for use on certain expenditures related to that customer's contract. Restricted cash balances are included as "Other current assets" in the condensed consolidated balance sheets. Our restricted cash balances were $ 184 million and $ 163 million at October 1, 2021 and January 1, 2021, respectively. Note 2–Revenues from Contracts with Customers Remaining Performance Obligations Remaining performance obligations ("RPO") represent the expected value of exercised contracts, both funded and unfunded, less revenue recognized to date. Remaining performance obligations do not include unexercised option periods and future potential task orders expected to be awarded under indefinite delivery/indefinite quantity ("IDIQ") contracts, General Services Administration Schedule or other master agreement contract vehicles, with the exception of certain IDIQ contracts where task orders are not competitively awarded and separately priced but instead are used as a funding mechanism, and where there is a basis for estimating future revenues and funding on future anticipated task orders. As of October 1, 2021, we had $ 14.6 billion of RPO and expect to recognize approximately 54 % and 71 % over the next 12 months and 24 months, respectively, with the remainder to be recognized thereafter. Disaggregation of Revenues We disaggregate revenues by customer-type, contract-type and geographic location for each of our reportable segments. These categories represent how the nature, timing and uncertainty of revenues and cash flows are affected. 9 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Disaggregated revenues by customer-type were as follows: Three Months Ended October 1, 2021 Nine Months Ended October 1, 2021 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) DoD and U.S. Intelligence Community $ 1,513 $ 19 $ 203 $ 1,735 $ 4,386 $ 45 $ 545 $ 4,976 Other government agencies (1) 215 619 450 1,284 724 1,849 1,292 3,865 Commercial and non-U.S. customers 281 121 28 430 859 377 80 1,316 Total $ 2,009 $ 759 $ 681 $ 3,449 $ 5,969 $ 2,271 $ 1,917 $ 10,157 Three Months Ended October 2, 2020 Nine Months Ended October 2, 2020 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) DoD and U.S. Intelligence Community $ 1,411 $ 14 $ 137 $ 1,562 $ 4,058 $ 43 $ 384 $ 4,485 Other government agencies (1) 292 628 358 1,278 675 1,787 980 3,442 Commercial and non-U.S. customers 248 105 25 378 679 288 80 1,047 Total $ 1,951 $ 747 $ 520 $ 3,218 $ 5,412 $ 2,118 $ 1,444 $ 8,974 (1) Includes federal government agencies other than the DoD and U.S. Intelligence Community, as well as state and local government agencies. Disaggregated revenues by contract-type were as follows: Three Months Ended October 1, 2021 Nine Months Ended October 1, 2021 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) Cost-reimbursement and fixed-price-incentive-fee $ 1,230 $ 397 $ 137 $ 1,764 $ 3,627 $ 1,176 $ 361 $ 5,164 Firm-fixed-price 540 245 443 1,228 1,619 755 1,254 3,628 Time-and-materials and fixed-price-level-of-effort 239 117 101 457 723 340 302 1,365 Total $ 2,009 $ 759 $ 681 $ 3,449 $ 5,969 $ 2,271 $ 1,917 $ 10,157 Three Months Ended October 2, 2020 Nine Months Ended October 2, 2020 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) Cost-reimbursement and fixed-price-incentive-fee $ 1,160 $ 363 $ 77 $ 1,600 $ 3,359 $ 1,052 $ 206 $ 4,617 Firm-fixed-price 597 278 348 1,223 1,499 740 958 3,197 Time-and-materials and fixed-price-level-of-effort 194 106 95 395 554 326 280 1,160 Total $ 1,951 $ 747 $ 520 $ 3,218 $ 5,412 $ 2,118 $ 1,444 $ 8,974 10 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Disaggregated revenues by geographic location were as follows: Three Months Ended October 1, 2021 Nine Months Ended October 1, 2021 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) United States $ 1,778 $ 726 $ 681 $ 3,185 $ 5,237 $ 2,158 $ 1,917 $ 9,312 International 231 33 — 264 732 113 — 845 Total $ 2,009 $ 759 $ 681 $ 3,449 $ 5,969 $ 2,271 $ 1,917 $ 10,157 Three Months Ended October 2, 2020 Nine Months Ended October 2, 2020 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) United States $ 1,731 $ 708 $ 520 $ 2,959 $ 4,804 $ 2,018 $ 1,444 $ 8,266 International 220 39 — 259 608 100 — 708 Total $ 1,951 $ 747 $ 520 $ 3,218 $ 5,412 $ 2,118 $ 1,444 $ 8,974 Revenues by customer-type, contract-type and geographic location exclude lease income of $ 34 million and $ 89 million for the three and nine months ended October 1, 2021, respectively, and $ 24 million and $ 71 million for the three and nine months ended October 2, 2020, respectively. Contract Assets and Liabilities Performance obligations are satisfied either over time as work progresses or at a point in time. Firm-fixed-price contracts are typically billed to the customer using milestone payments while cost-reimbursable and time and materials contracts are typically billed to the customer on a monthly or bi-weekly basis as indicated by the negotiated billing terms and conditions of the contract. As a result, the timing of revenue recognition, customer billings and cash collections for each contract results in a net contract asset or liability at the end of each reporting period. Contract assets consist of unbilled receivables, which is the amount of revenue recognized that exceeds the amount billed to the customer, where right to payment is not solely subject to the passage of time. Unbilled receivables exclude amounts billable where the right to consideration is unconditional. Contract liabilities consist of deferred revenue, which represents cash advances received prior to performance for programs and billings in excess of revenue recognized. The components of contract assets and contract liabilities consisted of the following: Balance sheet line item October 1, 2021 January 1, 2021 (in millions) Contract assets - current: Unbilled receivables Receivables, net $ 1,028 $ 906 Contract liabilities - current: Deferred revenue (1) Accounts payable and accrued liabilities $ 413 $ 481 Contract liabilities - non-current: Deferred revenue (1) Other long-term liabilities $ 21 $ 20 (1) Certain contracts record revenue on a net contract basis, and therefore, the respective deferred revenue balance will not fully convert to revenue. The increase in unbilled receivables was primarily due to revenue recognized on certain contracts partially offset by the timing of billings. The decrease in deferred revenue was primarily due to the timing of advance payments and revenue recognized during the period. 11 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Revenue recognized for the three and nine months ended October 1, 2021 of $ 31 million and $ 253 million, respectively, was included as a contract liability at January 1, 2021. Revenue recognized for the three and nine months ended October 2, 2020 of $ 41 million and $ 267 million, respectively, was included as a contract liability at January 3, 2020. Note 3–Acquisitions, Goodwill and Intangible Assets Gibbs & Cox Acquisition On May 7, 2021 (the "Purchase Date"), we completed the acquisition of Gibbs & Cox for purchase consideration of approximately $ 375 million, net of $ 1 million of cash acquired. Gibbs & Cox is an independent engineering and design firm specializing in naval architecture, marine engineering, management support and engineering consulting. The preliminary goodwill recognized of $ 190 million represents intellectual capital and the acquired assembled workforce, neither of which qualify for recognition as a separate intangible asset. All of the goodwill recognized is tax deductible. The following table summarizes the preliminary fair value of intangible assets acquired at the Purchase Date and the related weighted average amortization period: Weighted average amortization period Fair value (in years) (in millions) Programs 11 $ 175 As of October 1, 2021, we had not finalized the determination of fair values allocated to assets and liabilities, including, but not limited to, intangible assets, accounts receivables and accounts payable and accrued liabilities. 1901 Group Acquisition On January 14, 2021 (the "Closing Date"), we completed the acquisition of 1901 Group for purchase consideration of $ 212 million, net of $ 2 million of cash acquired. The preliminary goodwill recognized of $ 122 million represents intellectual capital and the acquired assembled workforce, none of which qualify for recognition as separate intangible assets. Of the goodwill recognized, $ 102 million is tax deductible. The following table summarizes the fair value of intangible assets acquired at the Closing Date and the related weighted average amortization period: Weighted average amortization period Fair value (in years) (in millions) Technology 8 $ 43 Programs 10 37 Backlog 1 6 Total 8 $ 86 As of October 1, 2021, we had not finalized the determination of fair values allocated to assets and liabilities, including, but not limited to accounts receivables and accounts payable and accrued liabilities. For the three and nine months ended October 1, 2021, $ 47 million and $ 97 million, respectively, of revenues related to the Gibbs & Cox and 1901 Group acquisitions were recognized within the Defense Solutions reportable segmen t. On September 21, 2021, we completed an inconsequential business acquisition for preliminary purchase consideration of approximately $ 36 million. The preliminary goodwill and intangible assets recognized in connection with the acquisition were $ 21 million and $ 8 million, respectively. 12 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SD&A Businesses Acquisition On May 4, 2020 (the "Transaction Date"), we completed the acquisition of L3Harris Technologies' security detection and automation businesses (the "SD&A Businesses"). The SD&A Businesses were acquired for cash consideration of $ 1,019 million, net of $ 27 million of cash acquired. The purchase consideration includes the initial cash payment of $ 1,015 million, plus a $ 31 million payment for contractual net working capital acquired. The SD&A Businesses provide airport and critical infrastructure screening products, automated tray return systems and other industrial automation products. The addition of the SD&A Businesses expands the scope and scale of our global security detection and automation offerings. The final goodwill of $ 574 million represents intellectual capital and the acquired assembled workforce. Of the goodwill recognized, $ 432 million is deductible for tax purposes. The following table summarizes the final fair value of intangible assets acquired at the Transaction Date and the related weighted average amortization period: Weighted average amortization period Fair value (in years) (in millions) Programs 13 $ 141 Customer relationships 10 49 Technology 10 73 In-process research and development ("IPR&D") (1) 92 Total 11 $ 355 (1) IPR&D assets are indefinite-lived at the acquisition date until placed into service, at which time such assets will be reclassified to a finite-lived amortizable intangible asset. For the nine months ended October 1, 2021 and October 2, 2020, $ 216 million and $ 154 million, respectively, of revenues related to the SD&A Businesses were recognized within the Civil reportable segment. Dynetics Acquisition On January 31, 2020 (the "Acquisition Date"), we completed our acquisition of Dynetics, an industry-leading applied research and national security solutions company. The addition of Dynetics will accelerate opportunities within our innovation engine that researches and develops new technologies and solutions to address the most challenging needs of our customers. All of the issued and outstanding shares of common stock of Dynetics were purchased for $ 1.64 billion, net of cash acquired. The final goodwill recognized of $ 789 million represents intellectual capital and the acquired assembled workforce. All of the goodwill recognized is deductible for tax purposes. The following table summarizes the final fair value of intangible assets acquired at the Acquisition Date and the related weighted average amortization period: Weighted average amortization period Fair value (in years) (in millions) Programs 13 $ 485 Backlog 1 32 Technology 11 11 Total 12 $ 528 For the nine months ended October 1, 2021 and October 2, 2020, $ 816 million and $ 637 million, respectively, of revenues related to Dynetics were recognized within the Defense Solutions reportable segment. 13 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Acquisition and Integration Costs The following expenses were incurred related to the acquisitions of Dynetics, the SD&A Businesses, 1901 Group and Gibbs & Cox: Three Months Ended Nine Months Ended October 1, 2021 October 2, 2020 October 1, 2021 October 2, 2020 (in millions) Acquisition costs $ — $ — $ 4 $ 23 Integration costs 5 4 14 7 Total acquisition and integration costs $ 5 $ 4 $ 18 $ 30 These acquisition and integration costs are recorded within Corporate and presented in "Acquisition, integration and restructuring costs" on the condensed consolidated statements of income. Goodwill The following table presents changes in the carrying amount of goodwill by reportable segment: Defense Solutions Civil Health Total (in millions) Goodwill at January 3, 2020 $ 2,039 $ 1,907 $ 966 $ 4,912 Goodwill re-allocation 429 ( 429 ) — — Acquisitions of businesses 788 569 — 1,357 Foreign currency translation adjustments 44 — — 44 Goodwill at January 1, 2021 3,300 2,047 966 6,313 Acquisitions of businesses 334 5 — 339 Goodwill re-allocation ( 17 ) 17 — — Foreign currency translation adjustments ( 28 ) 26 — ( 2 ) Goodwill at October 1, 2021 $ 3,589 $ 2,095 $ 966 $ 6,650 There were no goodwill impairments during the nine months ended October 1, 2021 and October 2, 2020. 14 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Intangible Assets Intangible assets, net consisted of the following: October 1, 2021 January 1, 2021 Gross carrying value Accumulated amortization Net carrying value Gross carrying value Accumulated amortization Net carrying value (in millions) Finite-lived intangible assets: Programs $ 1,853 $ ( 826 ) $ 1,027 $ 1,632 $ ( 687 ) $ 945 Software and technology 230 ( 115 ) 115 188 ( 100 ) 88 Customer relationships 97 ( 16 ) 81 93 ( 10 ) 83 Backlog 38 ( 36 ) 2 32 ( 29 ) 3 Trade names 1 ( 1 ) — 1 — 1 Total finite-lived intangible assets 2,219 ( 994 ) 1,225 1,946 ( 826 ) 1,120 Indefinite-lived intangible assets: In-process research and development 92 — 92 92 — 92 Trade names 4 — 4 4 — 4 Total indefinite-lived intangible assets 96 — 96 96 — 96 Total intangible assets $ 2,315 $ ( 994 ) $ 1,321 $ 2,042 $ ( 826 ) $ 1,216 Amortization expense was $ 63 million and $ 173 million for the three and nine months ended October 1, 2021, respectively, and $ 60 million and $ 154 million for the three and nine months ended October 2, 2020, respectively. Program intangible assets are amortized over their respective estimated useful lives in proportion to the pattern of economic benefit based on expected future discounted cash flows. Backlog and trade name intangible assets are amortized on a straight-line basis over their estimated useful lives. Customer relationships and software and technology intangible assets are amortized either on a straight-line basis over their estimated useful lives or over their respective estimated useful lives in proportion to the pattern of economic benefit based on expected future discounted cash flows, as deemed appropriate. The estimated annual amortization expense as of October 1, 2021, was as follows: Fiscal year ending (in millions) 2021 (remainder of year) $ 60 2022 244 2023 217 2024 165 2025 136 2026 and thereafter 403 $ 1,225 15 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 4–Fair Value Measurements The accounting standard for fair value measurements establishes a three-level fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: observable inputs such as quoted prices in active markets (Level 1); inputs other than quoted prices in active markets that are observable, either directly or indirectly, or quoted prices that are not active (Level 2); and unobservable inputs in which there is little or no market data (e.g., discounted cash flow and other similar pricing models), which requires us to develop our own assumptions about the assumptions that market participants would use in pricing the asset or liability (Level 3). The financial instruments measured at fair value on a recurring basis primarily consisted of the following: October 1, 2021 January 1, 2021 Carrying value Fair value Carrying value Fair value (in millions) Financial liabilities: Derivatives $ 70 $ 70 $ 103 $ 103 As of October 1, 2021, our derivatives primarily consisted of the cash flow interest rate swaps on $ 1.1 billion of the variable rate senior unsecured term loan (see "Note 5–Derivative Instruments"). The fair value of the cash flow interest rate swaps is determined based on observed values for underlying interest rates on the LIBOR yield curve and the underlying interest rate (Level 2 inputs). The carrying amounts of our financial instruments, other than derivatives, which include cash equivalents, accounts receivable, accounts payable and accrued expenses, are reasonable estimates of their related fair values. The carrying value of our notes receivable of $ 15 million as of October 1, 2021, and January 1, 2021, approximates fair value as the stated interest rates within the agreements are consistent with current market rates used in notes with similar terms in the market (Level 2 inputs). As of October 1, 2021, and January 1, 2021, the fair value of debt was $ 5.5 billion and $ 5.2 billion, respectively, and the carrying amount was $ 5.1 billion and $ 4.7 billion, respectively (see "Note 6–Debt"). The fair value of long-term debt is determined based on current interest rates available for debt with terms and maturities similar to our existing debt arrangements (Level 2 inputs). On May 7, 2021, January 14, 2021, May 4, 2020 and January 31, 2020, non-financial instruments measured at fair value on a non-recurring basis were recorded in connection with the acquisitions of Gibbs & Cox, 1901 Group, SD&A Businesses and Dynetics, respectively (see "Note 3–Acquisitions, Goodwill and Intangible Assets"). The fair values of the assets acquired and liabilities assumed were determined using Level 3 inputs. As of October 1, 2021, we did not have any assets or liabilities measured at fair value on a non-recurring basis. 16 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 5–Derivative Instruments We manage our risk to changes in interest rates through the use of derivative instruments. We do not hold derivative instruments for trading or speculative purposes. For variable rate borrowings, we use fixed interest rate swaps, effectively converting a portion of the variable interest rate payments to fixed interest rate payments. These swaps are designated as cash flow hedges. The fair value of the interest rate swaps was as follows: Liability derivatives Balance sheet line item October 1, 2021 January 1, 2021 (in millions) Cash flow interest rate swaps Other long-term liabilities $ 70 $ 103 The cash flows associated with the interest rate swaps are classified as operating activities in the condensed consolidated statements of cash flows. Cash Flow Hedges We have interest rate swap agreements to hedge the cash flows of $ 1.1 billion of the variable rate senior unsecured term loan (the "Variable Rate Loan"). These interest rate swap agreements have a maturity date of August 2025 and a fixed interest rate of 3.00 %. The objective of these instruments is to reduce variability in the forecasted interest payments of the Variable Rate Loan, which are based on the LIBOR rate. Under the terms of the interest rate swap agreements, we will receive monthly variable interest payments based on the one-month LIBOR rate and will pay interest at a fixed rate. The interest rate swap transactions were accounted for as cash flow hedges. The gain/loss on the swaps is reported as a component of other comprehensive income (loss) and is reclassified into earnings when the interest payments on the underlying hedged items impact earnings. A qualitative assessment of hedge effectiveness is performed on a quarterly basis, unless facts and circumstances indicate the hedge may no longer be highly effective. The effect of the cash flow hedges on other comprehensive income (loss) and earnings for the periods presented was as follows: Three Months Ended Nine Months Ended October 1, 2021 October 2, 2020 October 1, 2021 October 2, 2020 (in millions) Total interest expense, net presented in the condensed consolidated statements of income in which the effects of cash flow hedges are recorded $ 47 $ 44 $ 138 $ 133 Amount recognized in other comprehensive income (loss) $ — $ — $ 9 $ ( 62 ) Amount reclassified from accumulated other comprehensive income (loss) to interest expense, net $ 5 $ 5 $ 14 $ 9 We expect to reclassify net losses of $ 23 million from accumulated other comprehensive loss into earnings during the next 12 months. 17 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 6–Debt Our debt consisted of the following: Stated interest rate Effective interest rate October 1, 2021 (1) January 1, 2021 (1) (in millions) Short-term debt: Senior unsecured term loans: $ 380 million term loan, due May 2022 1.22 % 1.32 % $ 380 $ — Long-term debt: Senior unsecured term loans: $ 1,925 million term loan, due January 2025 1.47 % 1.73 % $ 1,321 $ 1,391 Senior unsecured notes: $ 500 million notes, due May 2023 (2) 2.95 % 3.17 % 498 497 $ 500 million notes, due May 2025 (2) 3.63 % 3.76 % 497 496 $ 750 million notes due May 2030 (2) 4.38 % 4.50 % 738 737 $ 1,000 million notes, due February 2031 (2) 2.30 % 2.38 % 990 989 $ 250 million notes, due July 2032 7.13 % 7.43 % 247 247 $ 300 million notes, due July 2033 5.50 % 5.88 % 158 158 $ 300 million notes, due December 2040 5.95 % 6.03 % 216 216 Notes payable and finance leases due on various dates through fiscal 2032 1.56 %- 4.18 % Various 55 13 Total long-term debt 4,720 4,744 Less current portion ( 104 ) ( 100 ) Total long-term debt, net of current portion $ 4,616 $ 4,644 (1) The carrying amounts of the senior term loans and notes as of October 1, 2021, and January 1, 2021, include the remaining principal outstanding of $ 5,090 million and $ 4,782 million, respectively, less total unamortized debt discounts and deferred debt issuances costs of $ 45 million and $ 51 million, respectively. (2) We filed a Registration Statement on Form S-4 with the Securities and Exchange Commission on May 6, 2021, and was declared effective on May 19, 2021. Term Loans and Revolving Credit Facility We have a Credit Agreement (the "Credit Agreement") with certain financial institutions, which provided for a senior unsecured term loan facility in an aggregate principal amount of $ 1.9 billion (the "Term Loan Facility") and a $ 750 million senior unsecured revolving facility (the "Revolving Facility"). Borrowings under the Credit Agreement bear interest at a rate determined, at our option, based on either an alternate base rate or a LIBOR rate plus, in each case, an applicable margin that varies depending on our credit rating. The applicable margin range for LIBOR-denominated borrowings is from 1.13 % to 1.75 %. Based on our current ratings, the applicable margin for LIBOR-denominated borrowings is 1.38 %. Principal payments are made quarterly on the Term Loan Facility, with the majority of the principal due at maturity. Interest on the Term Loan Facility for LIBOR-denominated borrowings is payable on a periodic basis, which must be at least quarterly. The financial covenants in the Credit Agreement require that we maintain, as of the last day of each fiscal quarter, a ratio of adjusted consolidated total debt to consolidated EBITDA of not more than 3.75 to 1.00, subject to two increases to 4.50 to 1.00 following a material acquisition, and a ratio of EBITDA to consolidated interest expense of not less than 3.50 to 1.00. 18 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) On May 7, 2021, we entered into a Credit Agreement (the "2021 Credit Agreement") with certain financial institutions, which provided for a senior unsecured term loan facility in an aggregate principal amount of $ 380 million with maturity 364 days after the 2021 Credit Agreement date. The proceeds were used to fund the acquisition of Gibbs & Cox. Borrowings under the 2021 Credit Agreement bear interest at a rate determined, at our option, based on either an alternate base rate plus 0.13 % or a LIBOR rate plus 1.13 %. The financial covenants in the 2021 Credit Agreement require that we maintain, as of the last day of each fiscal quarter, a ratio of adjusted consolidated total debt to consolidated EBITDA of not more than 3.75 to 1.00, subject to increases to 4.50 to 1.00 following a material acquisition, and a ratio of EBITDA to consolidated interest expense of not less than 3.50 to 1.00. The senior unsecured term loans, notes and revolving credit facility are fully and unconditionally guaranteed and contain certain customary restrictive covenants, including among other things, restrictions on our ability to create liens and enter into sale and leaseback transactions under certain circumstances. We were in compliance with all covenants as of October 1, 2021. Commercial Paper On July 12, 2021, we established a commercial paper program in which the Company may issue short-term unsecured commercial paper notes ("Commercial Paper Notes") not to exceed $ 750 million. The proceeds will be used for general corporate purposes, including working capital, capital expenditures, acquisitions and share repurchases. The Commercial Paper Notes will be issued in minimum denominations of $ 0.25 million and will have maturities of up to 397 days from the date of issuance. The Commercial Paper Notes will bear either a stated or floating interest rate, if interest bearing, or will be sold at a discount from the face amount. As of October 1, 2021, we did not have any Commercial Paper Notes outstanding. The Commercial Paper Notes will be fully and unconditionally guaranteed by an intercompany guarantee and contains certain customary restrictive covenants. Principal Payments and Debt Issuance Costs We made principal payments on our long-term debt of $ 27 million and $ 80 million during the three and nine months ended October 1, 2021, respectively, and $ 477 million and $ 705 million during the three and nine months ended October 2, 2020, respectively. This activity included required principal payments on our term loans of $ 24 million and $ 72 million during the three and nine months ended October 1, 2021, respectively, and $ 24 million and $ 48 million for the three and nine months ended October 2, 2020, respectively. During the nine months ended October 2, 2020, we made additional payments of $ 3,975 million, related to our refinancing activities. Additionally, on September 1, 2020, we retired our $ 450 million senior unsecured notes due December 2020. As of October 1, 2021 and January 1, 2021, there were no borrowings outstanding under the Revolving Facility. For the nine months ended October 2, 2020, $ 31 million of debt discount and debt issuance costs were written off related to the prior year refinancing activities. Amortization of debt discount and debt issuance costs was $ 3 million and $ 7 million for the three and nine months ended October 1, 2021, respectively, and $ 4 million and $ 13 million for the three and nine months ended October 2, 2020, respectively. 19 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 7–Accumulated Other Comprehensive Loss Changes in the components of accumulated other comprehensive loss were as follows: Foreign currency translation adjustments Unrecognized gain (loss) on derivative instruments Pension adjustments Total accumulated other comprehensive loss (in millions) Balance at January 3, 2020 $ ( 33 ) $ ( 33 ) $ ( 4 ) $ ( 70 ) Other comprehensive income (loss) 70 ( 61 ) ( 3 ) 6 Taxes ( 7 ) 10 1 4 Reclassification from accumulated other comprehensive loss — 14 — 14 Balance at January 1, 2021 30 ( 70 ) ( 6 ) ( 46 ) Other comprehensive income (loss) ( 8 ) 9 — 1 Taxes ( 4 ) ( 5 ) — ( 9 ) Reclassification from accumulated other comprehensive loss — 14 — 14 Balance at October 1, 2021 $ 18 $ ( 52 ) $ ( 6 ) $ ( 40 ) Reclassifications from unrecognized loss on derivative instruments are recorded in "Interest expense, net" in the condensed consolidated statements of income. Note 8–Earnings Per Share The following table provides a reconciliation of the weighted average number of shares outstanding used to compute basic and diluted EPS for the periods presented: Three Months Ended Nine Months Ended October 1, 2021 October 2, 2020 October 1, 2021 October 2, 2020 (in millions) Basic weighted average number of shares outstanding 141 142 141 142 Dilutive common share equivalents—stock options and other stock awards 2 2 2 2 Diluted weighted average number of shares outstanding 143 144 143 144 Anti-dilutive stock-based awards are excluded from the weighted average number of shares outstanding used to compute diluted EPS. The total outstanding stock options and vesting stock awards that were anti-dilutive were 1 million for both the three and nine months ended October 1, 2021, and the three and nine months ended October 2, 2020. During the three and nine months ended October 1, 2021, we made open market repurchases of our common stock for an aggregate purchase price of $ 137 million and $ 237 million, respectively. All shares repurchased were immediately retired. 20 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 9–Business Segments Our operations and reportable segments are organized around the customers and markets we serve. We define our reportable segments based on the way the chief operating decision maker ("CODM"), currently our Chairman and Chief Executive Officer, manages operations for the purposes of allocating resources and assessing performance. Effective July 3, 2021, certain contracts were reassigned from the Defense Solutions reportable segment to the Civil reportable segment. Impact on prior year segment results were determined to be immaterial and have not been recast to reflect this change. The segment information for the periods presented was as follows: Three Months Ended Nine Months Ended October 1, 2021 October 2, 2020 October 1, 2021 October 2, 2020 (in millions) Revenues: Defense Solutions $ 2,009 $ 1,951 $ 5,971 $ 5,413 Civil 792 771 2,357 2,183 Health 682 520 1,918 1,449 Total revenues $ 3,483 $ 3,242 $ 10,246 $ 9,045 Operating income (loss): Defense Solutions $ 140 $ 145 $ 429 $ 359 Civil 58 54 187 191 Health 130 75 339 149 Corporate ( 23 ) ( 16 ) ( 73 ) — Total operating income $ 305 $ 258 $ 882 $ 699 The income statement performance measures used to evaluate segment performance are revenues and operating income. As a result, "Interest expense, net," "Other income (expense), net" and "Income tax expense" as reported in the condensed consolidated statements of income are not allocated to our segments. Under U.S. Government Cost Accounting Standards, indirect costs including depreciation expense are collected in indirect cost pools, which are then collectively allocated to the reportable segments based on a representative causal or beneficial relationship of the costs in the pool to the costs in the base. As such, depreciation expense is not separately disclosed on the condensed consolidated statements of income. Asset information by segment is not a key measure of performance used by the CODM. Note 10–Commitments and Contingencies Legal Proceedings Class Action Lawsuit On March 2, 2021, Leidos and certain current officers of Leidos were named as defendants in a putative class action securities lawsuit filed in the U.S. District Court for the Southern District of New York. The complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder relating to alleged misstatements or omissions in Leidos' public filings with the SEC and other public statements during the period from May 4, 2020 to February 23, 2021 relating, among other things, to Leidos' acquisition of the SD&A Businesses. The plaintiff sought to recover from the Company and the individual defendants an unspecified amount of damages at this time. On July 30, 2021, the District Court appointed a lead plaintiff and lead counsel. On September 28, 2021, the lead plaintiff voluntarily dismissed the action without prejudice. 21 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Other Contingencies VirnetX, Inc. ("VirnetX") On April 10, 2018, a jury trial concluded in an additional patent infringement case brought by VirnetX against Apple, referred to as the Apple II case, in which the jury returned a verdict against Apple for infringement and awarded VirnetX damages in the amount of over $ 502 million. On April 11, 2018, in a second phase of the Apple II trial, the jury found Apple's infringement to be willful. On August 30, 2018, the federal trial court in the Eastern District of Texas entered a final judgment and rulings on post-trial motions in the Apple II case. The court affirmed the jury’s verdict of over $ 502 million and granted VirnetX’s motions for supplemental damages, a sunset royalty and royalty rate of $ 1.20 per infringing device, along with pre-judgment and post-judgment interest and costs. The court denied VirnetX’s motions for enhanced damages, attorneys’ fees and an injunction. The court also denied Apple’s motions for judgment as a matter of law and for a new trial. An additional sum of over $ 93 million for costs and pre-judgment interest was subsequently agreed upon pursuant to a court order, bringing the total award to VirnetX in the Apple II case to over $ 595 million. Apple filed an appeal of the judgment in the Apple II case with the U.S. Court of Appeals for the Federal Circuit, and on November 22, 2019, the Federal Circuit affirmed in part, reversed in part and remanded the Apple II case back to the District Court. The Federal Circuit affirmed that Apple infringed two of the patents at issue in the case, and ruled that Apple is precluded from making certain patent invalidity arguments. However, the Federal Circuit reversed the judgment that Apple infringed two other patents at issue, vacated the prior damages awarded in the Apple II case, and remanded the Apple II case back to the District Court for further proceedings regarding damages. On April 23, 2020, the District Court ordered a new trial on damages in the Apple II case, which was delayed by the coronavirus pandemic and started on October 26, 2020. On October 30, 2020, the jury awarded VirnetX $ 503 million in damages and specified a royalty rate of $ 0.84 per infringing device. In January 2021, the District Court entered final judgment affirming the jury award and the parties separately agreed on additional costs and interest of over $ 75 million, subject to Apple's appeal. On February 4, 2021, Apple filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit in the Apple II case. Under our agreements with VirnetX, Leidos would receive 25 % of the proceeds obtained by VirnetX after reduction for attorneys' fees and costs. However, the verdict in the Apple II case remains subject to the ongoing and potential future proceedings and appeals. In addition, the patents at issue in these cases are subject to U.S. Patent and Trademark Office post-grant inter partes review and/or reexamination proceedings and related appeals, which may result in all or part of these patents being invalidated or the claims of the patents being limited. Thus, no assurances can be given when or if we will receive any proceeds in connection with these jury awards. In addition, if Leidos receives any proceeds, we are required to pay a royalty to the customer who paid for the development of the technology. Government Investigations and Reviews We are routinely subject to investigations and reviews relating to compliance with various laws and regulations with respect to our role as a contractor to federal, state and local government customers and in connection with performing services in countries outside of the United States. Adverse findings could have a material effect on our business, financial position, results of operations and cash flows due to our reliance on government contracts. As of October 1, 2021, indirect cost active audits by the Defense Contract Audit Agency remain open for fiscal 2016 and subsequent fiscal years. Although we have recorded contract revenues based upon an estimate of costs that we believe will be approved upon final audit or review, we cannot predict the outcome of any ongoing or future audits or reviews and adjustments, and if future adjustments exceed estimates, our profitability may be adversely affected. As of October 1, 2021, we believe we have adequately reserved for potential adjustments from audits or reviews of contract costs. 22 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Commitments We have outstanding letters of credit of $ 68 million as of October 1, 2021, principally related to performance guarantees on contracts. We also have outstanding surety bonds with a notional amount of $ 132 million, principally related to performance and subcontractor payment bonds on contracts. The value of the surety bonds may vary due to changes in the underlying project status and/or contractual modifications. As of October 1, 2021, the future expirations of the outstanding letters of credit and surety bonds were as follows: Fiscal year ending (in millions) 2021 (remainder of year) $ 62 2022 114 2023 4 2024 2 2025 2 2026 and thereafter 16 $ 200 23 Table of Contents LEIDOS HOLDINGS, INC.