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Item 7. Management’s Discussion and Analysis

2022-02-15 compared with 2021-02-23 · 168 added, 255 removed, 251 unchanged (63% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of Leidos Holdings, Inc.'s ("Leidos") financial condition, results of operations and quantitative and qualitative disclosures about business environment and trends and market risk should be read in conjunction with the consolidated financial statements and related notes.

Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties, including those described under the heading “Forward-Looking Statements.” You should also review the disclosure under Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Unless indicated otherwise, references in this report to “we,” “us” and “our” refer collectively to Leidos and its consolidated subsidiaries.

The following discussion contains forward-looking statements, including statements regarding our intent, belief or current expectations with respect to, among other things, trends affecting our financial condition or results of operations, backlog, initiatives, our industry, the impact of our merger and acquisition activity, government budgets and spending, our business contingency plans and our ability to recover certain costs through the Coronavirus Aid, Relief and Economic Security Act ("CARES Act").

Such statements are not guarantees of future performance and involve risks and uncertainties, including uncertainties relating to the coronavirus pandemic ("COVID-19") and the actions taken by authorities and us to respond, and actual results may differ materially from those in the forward-looking statements as a result of various factors (see “Forward-Looking Statement Risks” within this Annual Report on Form 10-K).

Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in “Risk Factors" and "Business Environment and Trends.” Due to such uncertainties and risks, you are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date hereof.

We do not undertake any obligation to update these factors or to publicly announce the results of any changes to our forward-looking statements due to future events or developments.

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Annual Report - 39

We are a FORTUNE 500 ® science, engineering and information technology company that provides services and solutions in the defense, intelligence, homeland security, civil and health markets, both domestically and internationally.

We bring domain-specific capabilities and innovations to customers in each of these markets by leveraging five technical core competencies:

In this section, we discuss our financial condition, changes in financial condition and results of our operations for the year ended December 31, 2021 compared to the year ended January 1, 2021.

For a discussion and analysis comparing our results for the year ended January 1, 2021 to the year ended January 3, 2020, see our Annual Report on Form 10-K for the year ended January 1, 2021, filed with the SEC on February 23, 2021, under Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

We are a FORTUNE 500 ® technology, engineering, and science company that provides services and solutions in the defense, intelligence, civil and health markets, both domestically and internationally.

We bring domain-specific capabilities and innovations to customers in each of these markets by leveraging five technical capabilities:

digital modernization, cyber operations, mission software systems, integrated systems and mission operations.

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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.

civilian, state and local government agencies, foreign government agencies and commercial businesses.

Less than 8% of our revenues and tangible long-lived assets are generated by or owned by entities located outside of the United States.

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Additionally, we separately present the unallocable costs associated with corporate functions as Corporate.

Effective the beginning of fiscal 2020, certain contracts were reassigned from the Civil reportable segment to the Defense Solutions reportable segment.

Prior year segment results have been recast to reflect this change.

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.

For additional information regarding our reportable segments, see “Business” in Part I and "Note 20—Business Segments" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.

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• disciplined deployment of our cash resources and use of our capital structure to enhance shareholder value while retaining an appropriate amount of financial leverage.

For fiscal 2020, revenues increased $1.2 billion, or 11%, compared to fiscal 2019, primarily due to revenues related to the acquisitions of Dynetics, Inc.

("Dynetics") and L3Harris Technologies' security detection and automation businesses ("the SD&A Businesses"), program wins and a net increase in volumes on certain programs.

This was partially offset by the completion of certain contracts, negative impacts on certain contracts due to COVID-19 and the impact of the sale of our commercial cybersecurity and health staff augmentation businesses in the prior year.

For fiscal 2019, revenues increased $900 million, or 9%, compared to fiscal 2018, primarily due to program wins and a net increase in program volumes, partially offset by programs ended and the impact of the sale of our commercial cybersecurity and health staff augmentation businesses.

See "Results of Operations" below for discussion of our individual segment results.

For fiscal 2021, revenues increased $1.4 billion, or 12%, compared to fiscal 2020, primarily due to program wins and a net increase in volumes on certain programs, partially offset with the completion of certain contracts.

In addition, revenue had a positive impact from business acquisitions in the Defense Solutions segment and a reduction of the negative impacts from COVID-19 experienced during the prior year.

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Operating Expenses and Income Trend.

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Operating margin for fiscal 2021 was 8.4% compared to 8.1% for fiscal 2020.

Operating income was $998 million, an $86 million increase compared to fiscal 2019.

The increase in operating income was primarily attributable to program wins, income related to the acquisitions of Dynetics and the SD&A Businesses and a net gain recognized upon the receipt of proceeds related to the VirnetX, Inc.

("VirnetX") legal matter.

This was partially offset by negative impacts on certain contracts due to COVID-19, a net gain recognized in the prior year upon the receipt of the Greek arbitration award and increases in acquisition and integration costs and amortization expenses primarily associated with our current year acquisitions.

For fiscal 2019, operating expenses increased by $737 million, or 8%, compared to fiscal 2018.

Operating margin for fiscal 2019 was 8.2% compared to 7.3% for fiscal 2018.

Operating income was $1,152 million, a $154 million increase compared to fiscal 2020.

The increases in operating margin and operating income were primarily attributable to the receipt of the Greek arbitration award, favorable program mix, decreases in acquisition, integration and restructuring costs and lower amortization of intangible assets.

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The increase in operating income was primarily attributable to a net increase in volumes on certain programs, a reduction of the negative impacts from COVID-19 experienced during the prior year and program wins, partially offset by the completion of certain contracts.

From a macroeconomic perspective, our industry is under general competitive pressures associated with spending from our largest customer, the U.S.

government, and requires a high level of cost management focus to allow us to remain competitive.

Although the Administration has not indicated a desire to reduce spending in the defense and homeland security sectors, the likelihood, extent and duration of current spending levels in these areas remains unclear.

Although the U.S.

Presidential Administration has not indicated a desire to reduce spending in the defense and homeland security sectors, the likelihood, extent and duration of current spending levels in these areas remains unclear.

We continue to review our cost structure against our anticipated sales and undertake cost management actions and efficiency initiatives where necessary.

The COVID-19 pandemic is affecting major economic and financial markets, and effectively all industries and governments are facing challenges, which has resulted in a period of business disruption, the length and severity of which cannot be predicted.

The pandemic has resulted in significant travel restrictions, government orders to “shelter-in-place”, quarantine restrictions and significant disruption of the financial markets.

The pandemic has resulted in travel restrictions, government orders to “shelter-in-place”, quarantine restrictions and disruption of the financial markets.

We have acted to protect the health and safety of our employees, comply with workplace health and safety regulations and work with our customers to minimize disruptions.

The pandemic has impacted each of our groups, primarily in access to customer sites, travel restrictions, limitations of remote work and COVID-19 related costs.

Consistent with federal, state and local guidance, we perform work that is essential to support the critical infrastructure of the United States, the Defense Industrial Base and healthcare sector, and we continue to operate in support of our customers.

We have taken steps to support increased teleworking and safe workplace environments.

We have some minor business operations that are not designated as critical infrastructure and therefore have been required to operate in minimal conditions.

For fiscal 2020, COVID-19 adversely impacted revenues by approximately $198 million and impacted operating income by approximately $96 million as compared to prior year results.

The full extent of the impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute on programs in the expected timeframe, will depend on future developments, including the duration and spread of the pandemic and the distribution and efficacy of vaccines, all of which are uncertain and cannot be predicted.

While we have been able to make some recoveries, the ultimate timing and amount of recoveries remain uncertain as they will depend on a range of government actions, including each government agency and/or contracting officer's implementation of the authority granted in Section 3610 of the CARES Act, a $2 trillion coronavirus response bill providing widespread emergency relief, including the availability of funds.

As a result of Congress passing government fiscal year ("GFY") 2021 appropriations, the relief from the CARES Act has been extended until March 31, 2021.

We have experienced delays, and expect to continue experiencing delays, on certain contracts as a result of standby leave absences, which has caused a portion of our contracts to be less profitable.

Within our Health segment we saw recoveries in the fourth quarter of fiscal 2020 and continue to expect to see further recoveries in fiscal 2021.

Our Defense Solutions reportable segment experienced less of a negative impact in the fourth quarter of fiscal 2020 than in previous quarters.

We also experienced lower indirect expenditures for fiscal 2020 as a result of COVID-19 which partially offset the operating income impact on our programs.

We are seeking reimbursement of some of the COVID-19 related costs under our U.S.

government contracts through a combination of equitable adjustments to the contract prices and reimbursement of the costs under Section 3610, which allows, but does not require, federal agencies to reimburse contractors at the minimum applicable contract billing rate for costs arising from certain paid leave, including sick leave, a contractor provides to keep its employees or subcontractors in a ready state, including to protect the life and safety of government and contractor personnel.

Reimbursement of any costs under Section 3610 increases sales, but does not include a profit or fee and has the effect of reducing our margins.

Standby cost increases, including costs for employees whose jobs cannot be performed remotely, may not be fully recoverable under our contracts, particularly fixed-price contracts.

We also have no assurance that Congress will appropriate funds to cover the reimbursement of defense contractors authorized by the CARES Act, which could reduce funds available for recovery of these costs or for other U.S.

government defense priorities.

The CARES Act also enabled us to defer payment of the employer portion of social security taxes.

As of January 1, 2021, we deferred $123 million of employer social security tax payments and received $12 million from the Employee Retention Credit.

We have taken measures to protect the health and well-being of our workforce and are working with our customers to minimize the delay and disruption of the award and performance on our contracts.

Many of our employees continue to work remotely while our offices remain open with limited capacity.

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For fiscal 2021, while we continue to navigate impacts associated with COVID-19, primarily relating to supply chain matters, we believe that COVID-19 did not have a material impact to revenues and operating income as compared to prior year results.

The full extent of the impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute on programs in the expected timeframe, will depend on future developments, including the duration and spread of the pandemic and the distribution of vaccines, all of which are uncertain and cannot be predicted.

Section 3610 of the CARES Act, a $2 trillion coronavirus response bill providing widespread emergency relief, authorized the government to reimburse qualifying contractors for the cost of certain impacts of COVID-19.

While a portion of the recoveries that we have made are a result of Section 3610 of the CARES Act, the Act expired on September 30, 2021.

On September 9, 2021, President Biden issued a series of executive orders to combat COVID-19, one of which requires us, as a federal contractor, to have our employees fully vaccinated unless the employee is legally entitled to a religious or medical exemption.

This vaccine mandate is currently under a nationwide injunction, while courts adjudicate constitutional challenges to the executive order.

We are prepared to comply with the executive order in the event the injunction is lifted.

Business Environment and Trends

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government spending, especially national security, homeland security and intelligence spending, and the alignment of our service and product offerings and capabilities with current and future budget priorities of the U.S.

On February 10, 2020, the President submitted the GFY 2021 budget proposal to Congress, which included discretionary spending levels for defense and non-defense programs of $741 billion and $590 billion, respectively.

Shortly after the budget release, Congress and the Administration shifted their collective attention to mitigating the impact of COVID-19.

Prior to the beginning of GFY 2021, Congress passed a continuing resolution ("CR") that was enacted on October 1, 2020 to provide temporary funding for government operations at GFY 2020 enacted levels until December 11, 2020.

A series of short-term CRs were subsequently passed to extend temporary funding until the passage of GFY 2021 appropriations.

On December 20, 2020, Congress reached agreement on a comprehensive GFY 2021 Appropriations Package, and on December 27, 2020, the President signed the $1.4 trillion appropriations deal.

With the enactment of GFY 2021 spending levels, attention now turns to additional COVID-19 relief.

Immediately following that effort will be submission of a GFY 2021 supplemental aimed at economic recovery.

Completing action on these proposals may delay the President's GFY 2022 budget request, which is not expected to be submitted to Congress until late April or early May.

Congress received the GFY 2022 President’s Budget Request on May 28, 2021 and passed a Continuing Resolution ("CR") before the GFY deadline of September 30, 2021.

The CR fully funded the federal government at current levels through December 3, 2021 and provides $28.6 billion in disaster relief and $6.3 billion to support Afghanistan evacuees.

On December 2, 2021, Congress passed a second continuing resolution to fund the federal government at GFY 2021 levels until February 18, 2022.

The Senate plans to vote on a House-passed continuing resolution the week of February 14, 2022, that would extend government funding through March 11, 2022.

Congressional negotiations continue on defense and non-defense spending levels and controversial policy riders in the GFY 2022 appropriations bills.

President Biden is expected to release the GFY 2023 President’s Budget Request this spring.

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Trends in the U.S.

government contracting process, including a shift towards multiple-awards contracts, in which certain contractors are preapproved using indefinite-delivery/indefinite-quantity ("IDIQ") and U.S.

government contracting process, including a shift towards multiple-awards contracts, in which certain contractors are preapproved using IDIQ and U.S.

General Services Administration ("GSA") contract vehicles, have increased competition for U.S.

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International Markets

Sales to customers in international markets represented 8% of total revenues for fiscal 2020.

Sales to customers in international markets represented approximately 8% of total revenues for fiscal 2021.

Our international customers include foreign governments and their agencies.

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In addition, we consider business performance by contract type to be useful to management and investors when evaluating our operating income and margin performance.

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Results of Operations

Our results of operations for the periods presented were as follows:

Year Ended 2020 to 2019 2019 to 2018

Year Ended 2021 to 2020

2021 January 1,

2020 December 28,

2021 Dollar change Percent

change Dollar change Percent

(dollars in millions)

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Acquisition, integration and restructuring costs

39 5 37 34 NM (32) (86) %

27 39 (12) (31) %

Asset impairment charges

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Income tax expense

(152) (196) (28) 44 (22) % (168) NM

(208) (152) (56) 37 %

net income attributable to non-controlling interest 1 3 1 (2) (67) % 2 200 %

759 629 130 21 %

net income attributable to non-controlling interest 6 1 5 NM

Net income attributable to Leidos common stockholders $ 753 $ 628 $ 125 20 %

Operating income margin

8.1 % 8.2 % 7.3 %

NM - Not meaningful

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Segment and Corporate Results

Year Ended 2020 to 2019 2019 to 2018

Defense Solutions January 1,

Year Ended 2021 to 2020

Defense Solutions December 31,

2021 January 1,

2020 December 28,

2021 Dollar change Percent

change Dollar change Percent

(dollars in millions)

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Operating income margin

6.9 % 7.5 % 7.0 %

The increase in revenues for fiscal 2020 as compared to fiscal 2019 was primarily attributable to $937 million of revenues related to the acquisition of Dynetics, program wins and a net increase in materials volume on certain programs.

This was partially offset by the completion of certain contracts and approximately $51 million of negative impacts from reduced volume on certain contracts due to COVID-19.

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The increase in revenues for fiscal 2019 as compared to fiscal 2018 was primarily attributable to new awards and a net increase in program volumes, partially offset by the completion of certain contracts and adverse exchange rate movements in the Australian dollar and British pound when compared to the U.S.

The increase in operating income for fiscal 2020 as compared to fiscal 2019 was primarily attributable to income related to the acquisition of Dynetics, program wins and lower indirect expenditures.

This was partially offset by a net decrease in volumes on certain programs, including approximately $28 million of negative impacts on certain contracts due to COVID-19, and higher amortization of intangible assets related to the acquisition of Dynetics.

The increase in operating income for fiscal 2019 as compared to fiscal 2018 was primarily attributable to new awards, favorable program mix and the release of a contract reserve.

Year Ended 2020 to 2019 2019 to 2018

Civil January 1,

The increase in revenues for fiscal 2021 as compared to fiscal 2020 was primarily attributable to program wins, a net increase in volumes on certain programs, $149 million of revenues from new business acquisitions and a reduction of the negative impacts from COVID-19 experienced during the prior year.

The increase was partially offset by the completion of certain contracts and contracts that were reassigned from the Defense Solutions reportable segment to the Civil reportable segment during the third quarter.

In addition, in fiscal 2021, there was a $67 million benefit in exchange rate movements.

The increase in operating income for fiscal 2021 as compared to fiscal 2020 was primarily attributable to program wins, a net increase in program volumes on certain contracts, $18 million of operating income from new business acquisitions and a reduction of the negative impacts from COVID-19 experienced during the prior year, partially offset by the completion of certain contracts and an increase in amortization expense.

Year Ended 2021 to 2020

Civil December 31,

2021 January 1,

2020 December 28,

2018 Dollar change Percent change Dollar change Percent change

2021 Dollar change Percent change

(dollars in millions)

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Operating income margin

9.4 % 8.3 % 9.0 %

The increase in revenues for fiscal 2020 as compared to fiscal 2019 was primarily attributable to $243 million of revenues related to the acquisition of the SD&A Businesses and program wins.

This was partially offset by the completion of certain contracts and approximately $65 million of negative impacts from reduced volume on certain contracts due to COVID-19.

The increase in revenues for fiscal 2019 as compared to fiscal 2018 was primarily attributable to a net increase in program volumes and new awards, partially offset by the impact of the sale of our commercial cybersecurity business of $74 million, the completion of certain contracts and lower net profit write-ups in the current year.

The increase in operating income for fiscal 2020 as compared to fiscal 2019 was primarily attributable to program wins, a decrease in bad debt expense and lower indirect expenditures, partially offset by the completion of certain contracts.

The decrease in operating income for fiscal 2019 as compared to fiscal 2018 was primarily attributable to lower net profit write-ups in fiscal 2019 and a net increase in bad debt expense on certain international contracts, partially offset by lower amortization of intangibles of $18 million, a net increase in program volumes and the impact of the sale of our commercial cybersecurity business of $7 million.

Year Ended 2020 to 2019 2019 to 2018

Health January 1,

The increase in revenues for fiscal 2021 as compared to fiscal 2020 was primarily attributable to a net increase of $48 million of revenues related to L3 Harris Technologies' security and detection businesses (the "SD&A Businesses") acquired in the prior year, a net increase in program volumes, program wins and a reduction of the negative impacts from COVID-19 experienced during the prior year.

The revenue growth was also attributable to certain contracts that were reassigned from the Defense Solutions reportable segment to the Civil reportable segment during the third quarter.

The decrease in operating income for fiscal 2021 as compared to fiscal 2020 was primarily attributable to a net decrease in volumes on certain products and product deliveries, partially offset by a $26 million benefit from an adjustment to legal reserves related to the Mission Support Alliance joint venture during the first quarter of fiscal 2021.

Year Ended 2021 to 2020

Health December 31,

2021 January 1,

2020 December 28,

2021 Dollar change Percent

change Dollar change Percent

(dollars in millions)

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17.3 % 12.0 %

The decrease in revenues for fiscal 2020 as compared to fiscal 2019 was primarily attributable to approximately $82 million related to the timing of program execution due to COVID-19, a $73 million impact from the sale of our health staff augmentation business in the prior year and the completion of certain contracts.

This was partially offset by a net increase in volumes on certain programs, program wins and a $21 million impact from our acquisition of IMX Medical Management Services, Inc.

("IMX") in the prior year.

The increase in revenues for fiscal 2019 as compared to fiscal 2018 was primarily attributable to a net increase in program volumes, new awards and $18 million from our acquisition of IMX, partially offset by the completion of certain contracts and the impact of the sale of our health staff augmentation business of $78 million.

The increase in revenues for fiscal 2021 as compared to fiscal 2020 was primarily attributable to a net increase in volumes on certain programs, including a reduction of the negative impacts from COVID-19 experienced during the prior year and program wins, partially offset by the completion of certain contracts.

The increase in operating income for fiscal 2021 as compared to fiscal 2020 was primarily attributable to a net increase in volumes on higher margin programs, including a reduction of the negative impacts from COVID-19 experienced during the prior year, program wins and a net decrease in asset impairment charges.

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The decrease in operating income for fiscal 2020 as compared to fiscal 2019 was primarily attributable to approximately $67 million of negative impacts from reduced volume on certain managed service contracts with fixed cost infrastructures that were impacted by COVID-19.

This was partially offset by a net increase in volumes on certain programs and a $9 million impact from the sale of our health staff augmentation business in the prior year.

The increase in operating income for fiscal 2019 as compared to fiscal 2018 was primarily attributable to a net increase in program volumes, partially offset by reduced margins on awarded re-compete contracts.

Year Ended 2020 to 2019 2019 to 2018

Corporate January 1,

Year Ended 2021 to 2020

Corporate December 31,

2021 January 1,

2020 December 28,

2021 Dollar change Percent

change Dollar change Percent

(dollars in millions)

Operating loss $ (23) $ (32) $ (118) $ 9 (28) % $ 86 (73) %

The decrease in operating loss for fiscal 2020 as compared to fiscal 2019 was primarily attributable to an $81 million net gain recognized upon the receipt of proceeds related to the VirnetX legal matter and reduced indirect expenses due to COVID-19.

This was partially offset by a $52 million net gain recognized in the prior year upon the receipt of the Greek arbitration award and a $29 million increase in acquisition, integration and restructuring costs primarily associated with the acquisitions of Dynetics and the SD&A Businesses.

The decrease in operating loss for fiscal 2019 as compared to fiscal 2018 was primarily attributable to the $52 million net gain recognized upon the receipt of the Greek arbitration award, lower acquisition, integration and restructuring costs of $32 million and an asset impairment charge of $7 million in the prior year.

Operating loss $ (107) $ (23) $ (84) NM

NM - Not Meaningful

The increase in operating loss for fiscal 2021 as compared to fiscal 2020 was primarily attributable to an $81 million net gain recognized during the second quarter of fiscal 2020 upon receipt of proceeds related to the VirnetX, Inc.

legal matter and higher indirect expenses, partially offset by a decrease in acquisition, integration and restructuring costs.

Equity earnings of non-consolidated subsidiaries

We have certain non-controlling ownership interests in equity method investments.

For fiscal 2020, 2019 and 2018, we recorded earnings of $16 million, $29 million and $28 million, respectively, from our equity method investments, partially offset by amortization of $2 million , $11 million and $10 million, respectively.

For fiscal 2021 we recorded earnings of $20 million from our equity method investments.

For fiscal 2020 we recorded $16 million, partially offset by amortization of $2 million.

Non-Operating Expense, Net

Non-operating expense, net increased $171 million for fiscal 2020 as compared to fiscal 2019, primarily due to the $88 million gain recognized on the sale of our commercial cybersecurity business in the prior year, $36 million of debt discount and deferred financing costs written off and higher interest expense associated with increases in our long-term debt related to the financing of the acquisitions of Dynetics and the SD&A Businesses.

Non-operating expense, net decreased $93 million for fiscal 2019 as compared to fiscal 2018, primarily due to the $88 million gain recognized on the sale of our commercial cybersecurity business.

Non-operating expense, net decreased $32 million for fiscal 2021 as compared to fiscal 2020, primarily due to $36 million of debt discount and deferred financing costs written off related to refinancing activities in the prior year, partially offset by higher interest expenses.

Provision for Income Taxes

Our effective tax rate was 21.5%, and 19.5% in fiscal 2021 and 2020, respectively.

The effective tax rate for fiscal 2021 was favorably impacted primarily by federal research tax credits and excess tax benefits related to employee stock-based payment transactions.

The effective tax rate for fiscal 2020 was favorably impacted primarily by federal research tax credits and excess tax benefits related to employee stock-based payment transactions, partially offset by taxes related to foreign operations.

The effective tax rate for fiscal 2019 was favorably impacted primarily by excess tax benefits related to employee stock-based payment transactions and federal research tax credits, partially offset by an increase in valuation allowances arising from foreign withholding tax and an increase in taxes related to the sale of the commercial cybersecurity business.

The effective tax rate for fiscal 2018 was favorably impacted primarily by a decrease in valuation allowances arising from the taxable conversion of a subsidiary and the utilization of capital losses, an increase in deferred tax assets related to the stock basis of a subsidiary held for sale, excess tax benefits related to employee stock-based payment transactions and federal research tax credits .

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Beginning in 2022, the Tax Cuts and Jobs Act of 2017 eliminates the option to currently deduct research and development costs for tax purposes and requires taxpayers to capitalize and amortize research costs over five years.

Although it is possible that Congress may defer, modify, or repeal this provision, potentially with retroactive effect, we have no assurance that Congress will take any action with respect to this provision.

If the 2022 effective date remains in place, based on the law as currently enacted, our initial assessment is that our cash from operations will decrease by approximately $150 million in fiscal 2022 and our net deferred tax assets will increase by a similar amount.

The actual impact on fiscal 2022 cash from operations will depend on the amount of research and development costs the Company will incur, on whether Congress modifies or repeals this provision and on whether new guidance and interpretive rules are issued by the US Treasury, among other factors.

Non-controlling Interest

We have an 88% controlling interest in Mission Support Alliance, LLC ("MSA"), a joint venture with Centerra Group, LLC, which is anticipated to end in early fiscal 2021.

We have an 88% controlling interest in Mission Support Alliance, LLC ("MSA"), a joint venture with Centerra Group, LLC, which includes 41% purchased from Jacobs Group, LLC on January 26, 2018.

MSA’s contract ended on January 24, 2021.

We also have a 53% 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.

We include the financial results for MSA and HMIS in our consolidated financial statements.

Net income attributable to non-controlling interest was $1 million for fiscal 2020 and 2018 and $3 million for fiscal 2019.

Net income attributable to non-controlling interest was $6 million and $1 million for fiscal 2021 and 2020, respectively.

Bookings and Backlog

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We calculate net bookings as the year’s ending backlog, plus the year’s revenues, less the prior year’s ending backlog and any impacts from foreign currency or acquisitions and divestitures.

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Backlog represents the estimated amount of future revenues to be recognized under negotiated contracts.

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The estimated value of our total backlog for the periods presented was as follows:

2021 January 3,

December 31, 2021 January 1, 2021

Segment Funded Unfunded Total Funded Unfunded Total

(in millions)

Defense Solutions $ 4,393 $ 15,274 $ 19,667 $ 3,710 $ 14,721 $ 18,431

Funded backlog $ 3,710 $ 3,063

Negotiated unfunded backlog 14,721 11,974

Total Defense Solutions backlog $ 18,431 $ 15,037

Funded backlog $ 1,398 $ 1,267

Negotiated unfunded backlog 7,051 2,978

Total Civil backlog $ 8,449 $ 4,245

Funded backlog $ 1,486 $ 1,083

Negotiated unfunded backlog 3,546 3,725

Total Health backlog $ 5,032 $ 4,808

Funded backlog $ 6,594 $ 5,413

Negotiated unfunded backlog 25,318 18,677

Total backlog $ 31,912 $ 24,090

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The change in backlog for the Defense Solutions and Civil reportable segments reflect $1,632 million and $574 million, respectively, of backlog acquired as a result of the acquisitions of Dynetics and the SD&A Businesses, respectively.

(see "Note 6—Acquisitions" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K).

Civil 1,628 7,903 9,531 1,398 7,051 8,449

Health 1,428 3,829 5,257 1,486 3,546 5,032

Total $ 7,449 $ 27,006 $ 34,455 $ 6,594 $ 25,318 $ 31,912

The increase in backlog includes $800 million of backlog acquired in fiscal 2021 through business combinations in our Defense Solutions reportable segment.

Total backlog included an unfavorable impact of $52 million at December 31, 2021, and favorable impact of $119 million at January 1, 2021, primarily due to the movements in the British pound and Australian dollar when compared to the U.S dollar.

Bookings and backlog fluctuate from period to period depending on our success rate in winning contracts and the timing of contract awards, renewals, modifications and cancellations, as well as foreign currency movements.

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Most of our contracts have cancellation terms that would permit us to recover all or a portion of our incurred costs and fees for work performed.

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Contract Types

3 unchanged sentences

2021 January 1,

2020 December 28,

2021 January 3,

Cost-reimbursement and fixed-price-incentive-fee 50 % 51 % 54 %

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Overview of Liquidity

As of January 1, 2021, we had $524 million in cash and cash equivalents.

In January 2020, we entered into an unsecured revolving credit facility which can provide up to $750 million in additional borrowing, if required.

This new credit facility replaced the previous secured credit facility with the same borrowing capacity.

As of December 31, 2021, we had $727 million in cash and cash equivalents.

Additionally, we have an unsecured revolving credit facility which can provide up to $750 million in additional borrowing, if required.

During fiscal 2021 and 2020, there were no borrowings outstanding under the credit facilities and we were in compliance with the related financial covenants.

At January 1, 2021 and January 3, 2020, we had outstanding debt of $4.7 billion and $3.0 billion, respectively.

In January 2020, we entered into a 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").

We used the proceeds of the Term Loan Facility and cash on hand to repay in full all indebtedness, and terminate all commitments, under, and discharge and release all guarantees and liens existing in connection with the credit agreements entered into in August 2016.

Additionally, on January 17, 2020, we entered into a Bridge Credit Agreement with certain financial institutions, which provided for a senior unsecured 364-day bridge loan facility in an aggregate amount of $1.25 billion (the "Bridge Facility").

We used the proceeds of the Bridge Facility and cash on hand to fund the purchase of Dynetics.

In February 12, 2020, we entered into a senior unsecured delayed-draw term loan facility (the "Facility") providing for $1.0 billion of commitments from certain financial institutions in connection with the acquisition of the SD&A Businesses.

On May 4, 2020, we completed our acquisition of the SD&A Businesses and drew on the Facility in an aggregate principal amount of $1.0 billion.

The proceeds of the Facility and cash on hand were used to fund the purchase of the SD&A Businesses.

At December 31, 2021 and January 1, 2021, we had outstanding debt of $5.1 billion and $4.7 billion, respectively.

On May 7, 2021, we entered into a Credit Agreement which provided for a senior unsecured term loan facility in an aggregate principal amount of $380 million.

Additionally, on July 12, 2021, Leidos, Inc.

established a commercial paper program in which we may issue short-term unsecured commercial paper notes not to exceed $750 million and have maturities of up to 397 days from the date of issuance (see "Note 13—Debt").

As of December 31, 2021, we did not have any Commercial Paper Notes outstanding.

We made principal payments on our long-term debt of $106 million, $731 million, and $80 million during fiscal 2021, 2020 and 2019, respectively.

This activity included required principal payments on our term loans of $96 million, $72 million and $69 million during fiscal 2021, 2020 and 2019, respectively.

During fiscal year 2020, we made $4,925 million of principal repayments for outstanding debt and retired the $450 million senior notes.The notes outstanding as of December 31, 2021, contain financial covenants and customary restrictive covenants.

We were in compliance with all covenants as of December 31, 2021.

Interest on our Credit Facilities and 2021 Credit Agreement are calculated based on the London Interbank Offered Rate (“LIBOR”).

On July 27, 2017, the U.K.’s Financial Conduct Authority announced that LIBOR would be discontinued or become unavailable as a reference rate by the end of 2021 and LIBOR will be fully discontinued or become unavailable as a benchmark rate by June 2023.

Although our Credit Facilities and the 2021 Credit Agreement include mechanics to facilitate the adoption by us and our lenders of an alternative benchmark rate for use in place of LIBOR, no assurance can be made that such alternative benchmark rate will perform in a manner similar to LIBOR or result in interest rates that are at least as favorable to us as those that would have resulted had LIBOR remained in effect, which could result in an increase in our interest expense and other debt service obligations.

In addition, the overall credit market may be disrupted as a result of the replacement of LIBOR or in the anticipation thereof, which could have an adverse impact on our ability to refinance, reprice, or amend our existing indebtedness or incur additional indebtedness on favorable terms.

We paid dividends of $199 million, $196 million and $198 million for fiscal 2021, 2020 and 2019, respectively.

During the first and second quarter of fiscal 2021, we sold $693 million of accounts receivable under accounts receivable purchase agreements and received proceeds of $693 million (see "Note 6—Receivables").

There were no sales of accounts receivable in the second half of fiscal 2021.

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On May 12, 2020, we issued and sold $500 million senior notes maturing in May 2023, $500 million senior notes maturing in May 2025 and $750 million senior notes maturing in May 2030 (collectively, the "Notes").

The proceeds from the Notes were used to repay all of the outstanding obligations in respect of principal, interest and fees under the Bridge Credit Agreement and to repay a portion of the outstanding loans under the Facility.

On June 18, 2020, we entered into a 364-day Term Loan Credit Agreement, which provided for a senior unsecured term loan facility in an aggregate principal amount of $300 million (the "Term Loan").

The proceeds of the Term Loan and cash on hand on were used to repay in full all indebtedness under, and discharge and release all guarantees existing in connection with the Facility.

On September 1, 2020, we retired our $450 million senior unsecured notes due December 2020.

Cash on hand was used to repay in full all indebtedness under, and discharge and release all guarantees existing in connection with the notes.

On October 8, 2020, we issued and sold $1.0 billion aggregate principal amount of fixed-rate senior notes maturing in February 2031 (the "2031 Notes").

The proceeds from the 2031 Notes were used for general corporate purposes, including to repay all of the outstanding obligations in respect of principal, interest and fees under the 364-day Term Loan and to repay a portion of the outstanding loans under the five-year Term Loan Facility.

See "Note 15—Debt" for further details regarding the debt transactions noted above.

In addition to the refinancing activity noted above, we made principal payments on our long-term debt of $731 million, $80 million, and $59 million during fiscal 2020, 2019 and 2018, respectively.

This activity included required principal payments on our term loans of $72 million, $69 million and $46 million during fiscal 2020, 2019 and 2018, respectively.

In April 2018, we made a required debt prepayment of $10 million on our senior secured term loans.

The prepayment was a result of the annual excess cash flow calculation clause in our August 2016 credit agreements.

The notes outstanding as of January 1, 2021, contain financial covenants and customary restrictive covenants.

We were in compliance with all covenants as of January 1, 2021.

We paid dividends of $196 million for fiscal 2020 and $198 million for fiscal 2019 and 2018.

During fiscal 2020, we sold $1,866 million of accounts receivable under accounts receivable purchase agreements and received proceeds of $1,864 million (see "Note 22—Supplementary Cash Flow Information and Restricted Cash").

We may from time to time seek to retire or purchase our outstanding debt through cash purchases in the open market, privately negotiated transactions or otherwise.

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During fiscal 2021, 2020 and 2019, we made open market repurchases of our common stock for an aggregate purchase price of $237 million, $67 million and $25 million, respectively.

Additionally, during fiscal 2019 and 2018, we entered into ASR agreements with a financial institution, whereby we paid an aggregate of $400 million and $250 million, respectively, and received approximately 6 million and 4 million shares, respectively, of Leidos outstanding shares (see "Note 18—Earnings Per Share" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K).

Additionally, during fiscal 2019, we entered into ASR agreements with financial institutions, whereby we paid an aggregate of $400 million and received approximately 5.6 million shares of Leidos outstanding shares (see "Note 16—Earnings Per Share" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K).

The purchases were recorded to "Additional paid-in capital" in the consolidated balance sheets.

All shares delivered were immediately retired.

COVID-19 has negatively impacted the financial markets and may impact our liquidity;

we will continue to assess our liquidity needs as the pandemic and efforts to deploy vaccines evolve.

For the next 12 months, we anticipate that we will be able to meet our liquidity needs, including servicing our debt, through cash generated from operations, available cash balances, sales of accounts receivable and, if needed, borrowings from our revolving credit facility.

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Beginning in 2022, a provision in the Tax Cuts and Jobs Act of 2017 (“TCJA”) which eliminates the option to currently deduct research and development costs for tax purposes and requires taxpayers to capitalize and amortize the costs over five years becomes effective.

Congress may defer, modify or repeal the provision, but the ultimate outcome is uncertain.

The uncertainty surrounding the TCJA provision and the potential for COVID-19 to affect the financial markets may impact our liquidity.

If the 2022 effective date of the TCJA research cost capitalization provision remains in place, our initial assessment indicates we will have a negative impact to cash of approximately $150 million in fiscal 2022 and our net deferred tax assets will increase by a similar amount.

We will continue to assess our liquidity needs as the tax legislation and pandemic evolve.

Summary of Cash Flows

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2021 January 1,

2020 December 28,

(in millions)

Net cash provided by operating activities $ 1,031 $ 1,334

Net cash (used in) provided by investing activities (2,815) 65 (114)

Net cash provided by (used in) financing activities 1,451 (709) (707)

Net (decrease) increase in cash, cash equivalents and restricted cash $ (30) $ 348 $ (53)

Net cash provided by operating activities increased $342 million for fiscal 2020 as compared to fiscal 2019.

The increase was primarily due to the timing of payroll payments, including the deferral of $123 million of tax payments under the CARES Act, and the receipt of $85 million of proceeds related to the VirnetX legal matter.

Net cash provided by operating activities increased $224 million for fiscal 2019 as compared to fiscal 2018.

The increase was primarily due to more favorable timing of working capital changes including higher advance payments from customers, $59 million received for the Greek arbitration award and lower payments for integration and restructuring costs.

These activities were partially offset by higher tax payments, the timing of interest payments and $60 million of proceeds received from the termination of interest rate swaps in the prior year.

Net cash used in investing activities increased $2,880 million for fiscal 2020 as compared to fiscal 2019.

The increase was primarily due to $2,655 million of net cash paid related to the acquisitions of Dynetics and the SD&A Businesses, $178 million received in the prior year for the disposition of our commercial cybersecurity and health staff augmentation businesses, $96 million of proceeds received for the sale of real estate properties in the prior year and higher purchases of equipment and leasehold improvements associated with our new global headquarters.

This was partially offset by $94 million of cash paid related to the acquisition of IMX in the prior year.

Net cash provided by investing activities increased $179 million for fiscal 2019 as compared to fiscal 2018.

The increase was primarily due to $178 million of proceeds received for the dispositions of our commercial cybersecurity and health staff augmentation businesses, $96 million of proceeds received for the sale of real estate properties and $81 million of cash paid in the prior year related to our 2016 acquisition.

These activities were partially offset by $94 million of cash paid related to the acquisition of IMX, higher purchases of property, equipment and software and lower proceeds from promissory notes.

Net cash provided by financing activities increased $2,160 million for fiscal 2020 as compared to fiscal 2019.

The increase was primarily due to $7,225 million of proceeds received related to the refinancing and the issuance of new debt and higher stock repurchases in the prior year.

This was partially offset by $4,925 million of principal repayments of outstanding debt and the retirement of the $450 million senior notes in the current year.

Net cash used in investing activities (730) (2,815)

Net cash (used in) provided by financing activities (113) 1,451

Net increase (decrease) in cash, cash equivalents and restricted cash $ 188 $ (30)

Net cash provided by operating activities decreased $303 million for fiscal 2021 as compared to fiscal 2020.

The decrease was primarily due to the timing of customer advance payments, $62 million of deferral for employer payroll tax payments in the prior year and the receipt of $85 million of proceeds related to the VirnetX legal matter in the prior year, partially offset with improved collections on trade accounts receivable.

Net cash used in investing activities decreased $2,085 million for fiscal 2021 as compared to fiscal 2020.

The decrease was primarily due to larger acquisitions made in the prior year for Dynetics and the SD&A Businesses compared to our current year acquisitions (see "Note 5–Acquisitions and Divestitures") and lower capital expenditures in the current year.

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Net cash used in financing activities increased $1,564 million for fiscal 2021 as compared to fiscal 2020.

The increase was primarily due to the timing of debt payments and higher stock repurchases, partially offset by $23 million of cash paid related to a tax indemnification in the prior year and the timing of issuances of stock.

The increase was primarily due to a decrease of approximately $1,444 million from the net change of proceeds received from the issuance of debt, principal payments and payments for debt issuance costs, an increase of $170 million of open market stock repurchases, partially offset by a net $34 million increase in capital contributions received from our non-controlling interest.

Off-Balance Sheet Arrangements

We have outstanding performance guarantees and cross-indemnity agreements in connection with certain aspects of our business.

We also have letters of credit outstanding principally related to performance guarantees on contracts and surety bonds outstanding principally related to performance and subcontractor payment bonds as described in "Note 25—Commitments" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.

We also have letters of credit outstanding principally related to performance guarantees on contracts and surety bonds outstanding principally related to performance and subcontractor payment bonds as described in "Note 21—Commitments and Contingencies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.

These arrangements have not had, and management does not believe it is likely that they will in the future have, a material effect on our liquidity, capital resources, operations or financial condition.

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Contractual Obligations

The following table summarizes, as of January 1, 2021, our obligations to make future payments pursuant to certain contracts or arrangements and provides an estimate of the fiscal years in which these obligations are expected to be satisfied:

Total 2021 2022 2023 2024 2025 2026 and thereafter

The following table summarizes our obligations to make future payments pursuant to certain contracts or arrangements as of December 31, 2021:

Total Due in FY22

(in millions)

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Long-term debt (including current portion) $ 5,067 $ 477

$ 6,115 $ 244 $ 245 $ 807 $ 335 $ 1,454 $ 3,030

Interest payments 1,191 150

Operating lease obligations

790 148 126 108 94 69 245

Finance lease obligations 52 9

11 6 2 2 — — 1

Other long-term liabilities (3)

262 9 71 9 9 110 54

Other long-term liabilities and purchase obligations 308 35

Total contractual obligations $ 7,435 $ 833

(1) We have excluded purchase orders for services or products to be delivered pursuant to U.S.

The table above excludes purchase orders for services or products to be delivered pursuant to U.S.

government contracts for which we are entitled to full recourse under normal contract termination clauses.

(2) Includes total interest payments on our outstanding debt.

Interest payments represent $146 million, $148 million, $139 million, $142 million and $105 million of the balance for fiscal 2021, 2022, 2023, 2024 and 2025, respectively, and $651 million for fiscal 2026 and thereafter.

The total interest payments on our outstanding term loan debt are calculated based on the stated variable rates of the notes as of January 1, 2021.

The total interest payments on our outstanding senior unsecured notes are calculated based on the stated fixed rates.

(3) Other long-term liabilities were allocated by fiscal year as follows:

liabilities under deferred compensation arrangements are based upon the average annual payments in prior years upon termination of employment by participants and other liabilities are based on the fiscal year that the liabilities are expected to be realized.

The table above does not include income tax liabilities for uncertain tax positions of $4 million and $1 million of other tax liabilities, as we are not able to reasonably estimate the timing of payments in individual years due to uncertainties in the timing of audit outcomes and when settlements will become due.

There is no obligation included for our foreign defined benefit pension plan, as the plan is overfunded as of January 1, 2021.

Interest payments relate to our outstanding debt and finance leases.

The total interest payments on our outstanding term loan debt are calculated based on the stated variable rates of the notes as of December 31, 2021.

For more information on the Company’s debt and interest payments, see "Note 13—Debt " of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.

For more information on our finance and operating lease commitments, see "Note 10—Leases" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.

Other long-term liabilities include liabilities under deferred compensation arrangements and purchase obligations for long-term purchases and service agreements.

There is no obligation included for our foreign defined benefit pension plan, as the plan is overfunded as of December 31, 2021.

For a discussion of potential changes in these pension obligations, see "Note 19—Retirement Plans" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.

Guarantors and Issuers of Guaranteed Securities

has fully and unconditionally guaranteed the obligations of Leidos under its $300 million notes due December 2040.

Leidos has fully and unconditionally guaranteed the obligations of Leidos, Inc.

under its $300 million notes due July 2033, $250 million notes due July 2032, the Notes and the 2031 Notes.

The underlying subsidiaries of Leidos and Leidos Inc.

do not guarantee these obligations.

We have entered into registration rights agreements, pursuant to which we agreed to use reasonable best efforts to file registration statements to permit the exchange of the Notes and the 2031 Notes and related guarantees for registered notes having terms substantially identical thereto, or in the alternative, the registered resale of the Notes and 2031 Notes and related guarantees under certain circumstances.

See "Note 15—Debt" for further details.

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Summarized financial information for Leidos and Leidos Inc., net of eliminations, for the year ended January 1, 2021 was as follows (in millions):

Guarantors and Issuers of Guaranteed Securities

Leidos Holdings, Inc.

has fully and unconditionally guaranteed the obligations of its subsidiary, Leidos, Inc., under its $500 million notes due May 2023, $500 million notes due May 2025, $750 million due May 2030 and $1,000 million notes due February 2031 (collectively, "the Notes").

The underlying subsidiaries of Leidos, Inc.

do not guarantee these obligations and have been excluded from the financial information presented below.

We have entered into registration rights agreements, pursuant to which we agreed to use reasonable best efforts to file registration statements to permit the exchange of the Notes and related guarantees for registered notes having terms substantially identical thereto, or in the alternative, the registered resale of the Notes and related guarantees under certain circumstances.

Pursuant to these registration rights agreements, we filed a Registration Statement on Form S-4 with the Securities and Exchange Commission on May 6, 2021, which was declared effective on May 19, 2021.

Summarized financial information for Leidos and Leidos Inc., net of eliminations, for the year ended December 31, 2021 was as follows (in millions):

Balance Sheet

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Operating income 664

Net income 290

Net income attributable to Leidos common stockholders 274

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We are subject to a number of reviews, investigations, claims, lawsuits, other uncertainties and future obligations related to our business.

For a discussion of these items, see "Note 12—Leases," "Note 24—Contingencies" and "Note 25—Commitments" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.

For a discussion of these items, see "Note 10—Leases" and "Note 21—Commitments and Contingencies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.

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Critical Accounting Policies

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• Goodwill and Intangible Assets

• Income Taxes

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Revenue Recognition

Our revenues from contracts with customers are from offerings including digital modernization, cyber operations, mission software systems, integrated systems and mission operations, primarily with the U.S.

government and its agencies.

We also serve various state and local governments, foreign governments and commercial customers.

We perform under various types of contracts, which include firm-fixed-price ("FFP"), time-and-materials ("T&M"), fixed-price-level-of-effort ("FP-LOE"), cost-plus-fixed-fee ("CPFF"), cost-plus-award-fee, cost-plus-incentive-fee and fixed-price-incentive-fee contracts.

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In addition, we assess contract modifications to determine whether changes to existing contracts should be accounted for as part of the original contract or as a separate contract.

Contract modifications generally relate to changes in contract specifications and requirements and do not add distinct services, and therefore are accounted for as part of the original contract.

If contract modifications add distinct goods or services and increase the contract value by an amount that reflects the standalone selling price, those modifications are accounted for as separate contracts.

Most of our contracts are comprised of multiple promises including the design and build of software-based systems, integration of hardware and software solutions, running and maintaining of IT infrastructure and procurement services.

In all cases, we assess if the multiple promises should be accounted for as separate performance obligations or combined into a single performance obligation.

In cases where our contracts contain multiple promises, we assess if the multiple promises should be accounted for as separate performance obligations or combined into a single performance obligation.

We generally separate multiple promises in a contract as separate performance obligations if those promises are distinct, both individually and in the context of the contract.

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Contracts with the U.S.

government are subject to the Federal Acquisition Regulation ("FAR") and priced on estimated or actual costs of providing the goods or services.

government are subject to the FAR and priced on estimated or actual costs of providing the goods or services.

The FAR provides guidance on types of costs that are allowable in establishing prices for goods and services provided to the U.S.

8 unchanged sentences

We estimate variable consideration at the most probable amount that we expect to be entitled to, based on the assessment of the contractual variable fee criteria, complexity of work and related risks, extent of customer discretion, amount of variable consideration received historically and the potential of significant reversal of revenue.

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We allocate the transaction price of a contract to its performance obligations in the proportion of its respective standalone selling prices.

1 unchanged sentence

For certain product sales, prices from other standalone sales are used.

Substantially all of our contracts do not contain a significant financing component, which would require an adjustment to the transaction price of the contract.

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We recognize revenue on our service-based contracts primarily over time as there is continuous transfer of control to the customer over the duration of the contract as the promised services are performed.

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Anticipated losses on service-based contracts are recognized when incurred (generally on a straight-line basis) over the contract term.

In certain product sales, where the products have an alternate use, revenue is recognized at a point in time when the customer takes control of the asset usually denoted by possession and legal title.

On FFP contracts requiring system integration and cost-plus contracts with variable consideration, revenue is recognized over time generally using a method that measures the extent of progress towards completion of a performance obligation, principally using a cost-input method (referred to as the cost-to-cost method).

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We recognize purchased intangible assets in connection with our business acquisitions at fair value on the acquisition date.

Goodwill and intangible assets, net collectively represent 60% and 58% of our total assets as of January 1, 2021 and January 3, 2020, respectively.

Goodwill and intangible assets, net collectively represent 60% of our total assets as of December 31, 2021 and January 1, 2021.

Goodwill is not amortized, but instead is tested annually for impairment at the reporting unit level and tested more frequently if events or circumstances indicate that the carrying value may not be recoverable.

Our policy is to perform our annual goodwill impairment evaluation as of the first day of the fourth quarter of our fiscal year.

During fiscal 2020 and 2019, we had seven and six reporting units, respectively, for the purpose of testing goodwill for impairment.

Estimating the fair value of a reporting unit and intangibles requires the exercise of significant judgment and assumptions including judgments about expected future cash flows, weighted-average cost of capital, discount rates and expected long-term growth rates.

In some cases, we use discounted cash flow analyses, which are based on estimates of future sales, earnings and cash flows after considering such factors as general market conditions, customer budgets, existing firm and future orders, changes in working capital, long term business plans and recent operating performance.

Our policy is to perform our annual goodwill impairment evaluation as of the first day of the fourth quarter of our fiscal year using either a qualitative or quantitative approach.

During both fiscal 2021 and 2020, we had seven reporting units.

In our qualitative assessment, we determine whether it is more likely than not that an impairment exists based on qualitative factors.

Qualitative factors include macroeconomic, industry and market considerations, overall financial performance, industry, legal and other relevant events and factors affecting the reporting unit.

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Additionally, as part of this assessment, we may perform a quantitative analysis to support the qualitative factors above by applying sensitivities to assumptions and inputs used in measuring a reporting unit’s fair value.

If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed.

We use discounted cash flow analyses and market multiple analyses in order to estimate reporting unit fair values.

Discounted cash flow analyses rely on significant judgement and assumptions about expected future cash flows, weighted-average cost of capital, discount rates, expected long-term growth rates and operating margins.

These assumptions are based on estimates of future sales and earnings after considering such factors as general market conditions, customer budgets, existing firm and future orders, changes in working capital, long term business plans and recent operating performance.

Market multiple analyses incorporate significant judgments and assumptions related to the selection of guideline public companies, our forecast earnings before interest, taxes, depreciation and amortization (“EBITDA”), forecast EBITDA of guideline public companies and control premium estimates.

A significant change to these estimates and assumptions could cause the estimated fair values of our reporting units and intangible assets to decline and increase the risk of an impairment charge to earnings.

Intangible assets with finite lives are assessed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

We performed our annual test for impairment as of October 2, 2021, which resulted in no impairments being identified.

However, through this analysis we determined that our Security Products reporting unit within the Civil reportable segment, which holds goodwill in the amount of $926 million as of December 31, 2021, was at risk of future impairment.

The estimated fair value of the Security Products reporting unit exceeded the carrying value by approximately 6%.

Operations of the reporting unit rely heavily on the sales and servicing of security and detection products, which have been negatively impacted by COVID-19.

The forecasts utilized to estimate the fair value of the Security Products reporting unit assume a gradual improvement in the global aviation security product and related service sales, reaching pre-COVID-19 levels by fiscal 2025.

In the event that there are significant unfavorable changes to the forecasted cash flows of the reporting unit (including if the impact of COVID-19 on passenger travel levels is more prolonged or severe than what is incorporated into our forecast), terminal growth rates or the cost of capital used in the fair value estimates, we may be required to record a material impairment of goodwill at a future date.

Intangible assets with indefinite lives are not amortized but are assessed for impairment at the beginning of the fourth quarter and whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

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We account for income taxes under the asset and liability method in accordance with the accounting standard for income taxes.

The asset and liability method requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities.

Under this method, changes in tax rates and laws are recognized in income in the period such changes are enacted.

We record net deferred tax assets to the extent we believe these assets will more likely than not be realized.

In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent results of operations.

If we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount or would no longer be able to realize our deferred income tax assets in the future as currently recorded, we would make an adjustment to the valuation allowance which would decrease or increase the provision for income taxes.

The provision for federal, state, foreign and local income taxes is calculated on income before income taxes based on current tax law and includes the cumulative effect of any changes in tax rates from those used previously in determining deferred tax assets and liabilities.

Such provision differs from the amounts currently payable because certain items of income and expense are recognized in different reporting periods for financial reporting purposes than for income tax purposes.

We recognize liabilities for uncertain tax positions when it is more likely than not that a tax position will not be sustained upon examination and settlement with various taxing authorities.

Liabilities for uncertain tax positions are measured based upon the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.

We recognize interest and penalties related to uncertain tax positions in our income tax expense.

Each quarter, we evaluate impairment indicators to determine whether there is a triggering event warranting a goodwill and intangible asset impairment analysis.

Recently Adopted and Issued Accounting Pronouncements

1 unchanged sentence

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis