Leidos Holdings, Inc. 10-K

Item 7. 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 included elsewhere in this Annual Report on Form 10-K. 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. 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.” Overview 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. Our 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, 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. We operate in three reportable segments: Defense Solutions, Civil and Health. Additionally, we separately present the unallocable costs associated with corporate functions as Corporate. 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. Our significant initiatives include the following: • achieving annual revenue growth through internal collaboration and better leveraging of key differentiators across our company and the deployment of resources and investments into higher growth markets; • increasing headcount and internal direct labor content on our contract portfolio; • continued improvement in our back office infrastructure and related business processes for greater effectiveness and efficiency across all business functions; and • disciplined deployment of our cash resources and use of our capital structure to enhance shareholder value while retaining an appropriate amount of financial leverage. Sales Trend. 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. Leidos Holdings, Inc. Annual Report - 36 Table of Contents PART II Operating Expenses and Income Trend. For fiscal 2021, operating expenses increased by $1.3 billion, or 11%, compared to fiscal 2020. Operating margin for fiscal 2021 was 8.4% compared to 8.1% for fiscal 2020. Operating income was $1,152 million, a $154 million increase compared to fiscal 2020. 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 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. COVID-19 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 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. 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 U.S. Government Markets In fiscal 2021, we generated approximately 87% of our total revenues from contracts with the U.S. government, either as a prime contractor or a subcontractor to other contractors engaged in work for the U.S. government. Revenues under contracts with the DoD and U.S. Intelligence Community, including subcontracts under which the DoD or the U.S. Intelligence Community is the ultimate purchaser, represented approximately 44% of our total revenues for fiscal 2021. Accordingly, our business performance is affected by the overall level of U.S. 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. government. 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. Leidos Holdings, Inc. Annual Report - 37 Table of Contents PART II Trends in the 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. government contracts, reduced backlogs by shortening periods of performance on contracts and increased pricing pressure. We expect that a majority of the business that we seek in the foreseeable future will be awarded through a competitive bidding process. For more information on these risks and uncertainties, see “Risk Factors” in Part I of this Annual Report on Form 10-K. International Markets Sales to customers in international markets represented approximately 8% of total revenues for fiscal 2021. Our international customers include foreign governments and their agencies. Our international business increases our exposure to international markets and the associated international regulatory, foreign currency exchange rate and geopolitical risks. Changes in international trade policies, including higher tariffs on imported goods and materials, may increase our procurement costs of certain IT hardware used both on our contracts and for internal use. However, we expect to recover certain portions of these higher tariffs through our cost-plus contracts. While we evaluate the impact of higher tariffs, currently, we do not expect tariffs to have a significant impact to our business. Key Performance Measures The primary financial performance measures we use to manage our business and monitor results of operations are revenue, operating income, cash flows from operations and diluted earnings per share. Bookings and backlog are also useful measures for management and investors to evaluate our performance and potential future revenues. In addition, we consider business performance by contract type to be useful to management and investors when evaluating our operating income and margin performance. Results of Operations Our results of operations for the periods presented were as follows: Year Ended 2021 to 2020 December 31, 2021 January 1, 2021 Dollar change Percent change (dollars in millions) Revenues $ 13,737 $ 12,297 $ 1,440 12 % Cost of revenues 11,723 10,560 1,163 11 % Selling, general and administrative expenses 860 770 90 12 % Bad debt expense and recoveries (9) (68) 59 (87) % Acquisition, integration and restructuring costs 27 39 (12) (31) % Asset impairment charges 4 12 (8) (67) % Equity earnings of non-consolidated subsidiaries (20) (14) (6) 43 % Operating income 1,152 998 154 15 % Non-operating expense, net (185) (217) 32 NM Income before income taxes 967 781 186 24 % Income tax expense (208) (152) (56) 37 % Net income 759 629 130 21 % Less: 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 8.4 % 8.1 % NM - Not meaningful Leidos Holdings, Inc. Annual Report - 38 Table of Contents PART II Segment and Corporate Results Year Ended 2021 to 2020 Defense Solutions December 31, 2021 January 1, 2021 Dollar change Percent change (dollars in millions) Revenues $ 8,032 $ 7,341 $ 691 9 % Operating income 569 506 63 12 % Operating income margin 7.1 % 6.9 % 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, 2021 Dollar change Percent change (dollars in millions) Revenues $ 3,157 $ 2,994 $ 163 5 % Operating income 248 280 (32) (11) % Operating income margin 7.9 % 9.4 % 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, 2021 Dollar change Percent change (dollars in millions) Revenues $ 2,548 $ 1,962 $ 586 30 % Operating income 442 235 207 88 % Operating income margin 17.3 % 12.0 % 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. Leidos Holdings, Inc. Annual Report - 39 Table of Contents PART II Year Ended 2021 to 2020 Corporate December 31, 2021 January 1, 2021 Dollar change Percent change (dollars in millions) 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 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 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. 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 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 $6 million and $1 million for fiscal 2021 and 2020, respectively. Bookings and Backlog We had net bookings of $15.5 billion and $17.8 billion during fiscal 2021 and 2020, respectively. Net bookings represent the estimated amount of revenue to be earned in the future from funded and unfunded contract awards that were received during the year, net of any adjustments to previously awarded backlog amounts. 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. Leidos Holdings, Inc. Annual Report - 40 Table of Contents PART II Backlog represents the estimated amount of future revenues to be recognized under negotiated contracts. We segregate our backlog into two categories as follows: • Funded Backlog. Funded backlog for contracts with the U.S. government represents the value on contracts for which funding is appropriated less revenues previously recognized on these contracts. Funded backlog for contracts with non-U.S. government entities and commercial customers represents the estimated value on contracts, which may cover multiple future years, under which we are obligated to perform, less revenues previously recognized on the contracts. • Negotiated Unfunded Backlog. Negotiated unfunded backlog represents estimated amounts of revenue to be earned in the future from contracts for which funding has not been appropriated and unexercised priced contract options. Negotiated unfunded backlog does not include unexercised option periods and future potential task orders expected to be awarded under IDIQ, GSA 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. The estimated value of our total backlog for the periods presented was as follows: Year ended 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 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. Contract awards may be negatively impacted by ongoing industry-wide delays in procurement decisions and budget cuts by the U.S. government as discussed in “Business Environment and Trends” in this Annual Report on Form 10-K. We expect to recognize a substantial portion of our funded backlog as revenues within the next 12 months. However, the U.S. government may cancel any contract at any time through a termination for the convenience of the U.S. government. In addition, certain contracts with commercial or non-U.S. government customers may include provisions that allow the customer to cancel at any time. 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. Leidos Holdings, Inc. Annual Report - 41 Table of Contents PART II Contract Types Our earnings and profitability may vary materially depending on changes in the proportionate amount of revenues derived from each type of contract. For a discussion of the types of contracts under which we generate revenues, see “Business—Contract Types” in Part I of this Annual Report on Form 10-K. Revenues by contract type as a percentage of our total revenues for the periods presented were as follows: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 Cost-reimbursement and fixed-price-incentive-fee 50 % 51 % 54 % Firm-fixed-price 37 % 36 % 33 % Time-and-materials and fixed-price-level-of-effort 13 % 13 % 13 % Total 100 % 100 % 100 % Liquidity and Capital Resources Overview of Liquidity 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 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. Leidos Holdings, Inc. Annual Report - 42 Table of Contents PART II 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. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. Stock repurchases of Leidos common stock may be made on the open market or in privately negotiated transactions with third parties including through accelerated share repurchase ("ASR") agreements. Whether repurchases are made and the timing and actual number of shares repurchased depends on a variety of factors including price, corporate capital requirements, other market conditions and regulatory requirements. The repurchase program may be accelerated, suspended, delayed or discontinued at any time. 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, 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. 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. 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 and commercial paper program. Summary of Cash Flows The following table summarizes cash flow information for the periods presented: Year Ended December 31, 2021 January 1, 2021 (in millions) Net cash provided by operating activities $ 1,031 $ 1,334 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. Leidos Holdings, Inc. Annual Report - 43 Table of Contents PART II Net cash used in financing activities increased $1,564 million for fiscal 2021 as compared to fiscal 2020. 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 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. Contractual Obligations 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) Contractual obligations: Long-term debt (including current portion) $ 5,067 $ 477 Interest payments 1,191 150 Operating lease obligations 817 162 Finance lease obligations 52 9 Other long-term liabilities and purchase obligations 308 35 Total contractual obligations $ 7,435 $ 833 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. 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. Leidos Holdings, Inc. Annual Report - 44 Table of Contents PART II 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 Total current assets $ 2,229 Goodwill 4,171 Investments in consolidated subsidiaries 4,918 Other long-term assets 1,362 $ 12,680 Total current liabilities $ 2,400 Long-term debt, net of current portion 4,590 Intercompany payables 1,438 Other long-term liabilities 849 Total liabilities 9,277 Total equity 3,403 $ 12,680 Income Statement Revenues, net $ 9,240 Operating income 664 Net income attributable to Leidos common stockholders 274 Commitments and Contingencies 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 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. Leidos Holdings, Inc. Annual Report - 45 Table of Contents PART II Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements in accordance 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. Our estimates and assumptions have been prepared by management on the basis of the most current and best available information. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions and conditions. We have identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our results of operations or financial condition. • Revenue Recognition • Goodwill and Intangible Assets Revenue Recognition 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. To determine the proper revenue recognition, we first evaluate whether we have a duly approved and enforceable contract with a customer, in which the rights of the parties and payment terms are identified, and collectability is probable. We also evaluate whether two or more contracts should be combined and accounted for as a single contract, including the task orders issued under an IDIQ award. 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. 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. 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. If multiple promises in a contract are highly interrelated or require significant integration or customization within a group, they are combined and accounted for as a single performance obligation. Our contracts with the U.S. government often contain options to renew existing contracts for an additional period of time (generally a year at a time) under the same terms and conditions as the original contract, and generally do not provide the customer any material rights under the contract. We account for renewal options as separate contracts when they include distinct goods or services at standalone selling prices. Contracts with the U.S. 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. government and its agencies. Each contract is competitively priced and bid separately. Pricing for non-U.S. government agencies and commercial customers is based on specific negotiations with each customer. In circumstances where the standalone selling price is not directly observable, we estimate the standalone selling price using the expected cost-plus margin approach. Any taxes collected or imposed when determining the transaction price are excluded. Certain cost-plus and fixed-price contracts contain award fees, incentive fees or other provisions that may either increase or decrease the transaction price. These variable amounts generally are awarded upon achievement of certain performance metrics, program milestones or cost targets and can be based upon customer discretion. 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. Leidos Holdings, Inc. Annual Report - 46 Table of Contents PART II We allocate the transaction price of a contract to its performance obligations in the proportion of its respective standalone selling prices. The standalone selling price of the performance obligations is generally based on an expected cost-plus margin approach, in accordance with the FAR. For certain product sales, prices from other standalone sales are used. 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. For U.S. government contracts, continuous transfer of control to the customer is evidenced by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay for costs incurred plus a reasonable profit and take control of any work-in-process. Similarly, for non-U.S. government contracts, the customer typically controls the work-in-process as evidenced by rights to payment for work performed to date plus a reasonable profit to deliver products or services for which we do not have an alternate use. 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, transfer of legal title and acceptance by the customer. 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). Under the cost-to-cost method, revenue is recognized based on the proportion of total costs incurred to estimated total costs-at-completion ("EAC"). A performance obligation's EAC includes all direct costs such as materials, labor, subcontract costs, overhead and a ratable portion of general and administrative costs. In addition, an EAC of a performance obligation includes future losses estimated to be incurred on onerous contracts, as and when known. On certain other contracts, principally T&M, FP-LOE and CPFF, revenue is recognized using the right-to-invoice practical expedient as we are contractually able to invoice the customer based on the control transferred to the customer. Additionally, on maintenance (generally FFP) performance obligations, revenue is recognized over time using a straight-line method as the control of the services is provided to the customer evenly over the period of performance. For certain performance obligations where we are not primarily responsible for fulfilling the promise to provide the goods or service to the customer, do not have inventory risk and do not have discretion in establishing the price for the goods or service, we recognize revenue on a net basis. Goodwill and Intangible Assets Goodwill represents the excess of the fair value of consideration transferred, plus the fair value of any non-controlling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. 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% 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 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. Leidos Holdings, Inc. Annual Report - 47 Table of Contents PART II 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. 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 For a discussion of these items, see "Note 2—Accounting Standards" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.