Leidos Holdings, Inc. 10-K

Item 8. Financial Statements and Supplementary Data LEIDOS HOLDINGS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34 ) 51 Consolidated Balance Sheets as of December 31, 2021 and January 1, 2021 54 Consolidated Statements of Income for the fiscal years ended December 31, 2021, January 1, 2021 and January 3, 2020 55 Consolidated Statements of Comprehensive Income for the fiscal years ended December 31, 2021, January 1, 2021 and January 3, 2020 56 Consolidated Statements of Equity for the fiscal years ended December 31, 2021, January 1, 2021 and January 3, 2020 57 Consolidated Statements of Cash Flows for the fiscal years ended December 31, 2021, January 1, 2021 and January 3, 2020 58 Notes to Consolidated Financial Statements 60 Financial statement schedules are omitted because they are not applicable or the required information is presented in the consolidated financial statements or the notes thereto. Leidos Holdings, Inc. Annual Report - 50 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the shareholders and the Board of Directors of Leidos Holdings, Inc. Reston, Virginia Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Leidos Holdings, Inc. and subsidiaries (the "Company") as of December 31, 2021 and January 1, 2021, the related consolidated statements of income, comprehensive income, equity, and cash flows, for the fiscal years ended December 31, 2021, January 1, 2021, and January 3, 2020, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and January 1, 2021, and the results of its operations and its cash flows for the fiscal years ended December 31, 2021, January 1, 2021, and January 3, 2020, in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2021, based on criteria established in Internal Control — Integrated Framework (2013 ) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 15, 2022, expressed an unqualified opinion on the Company's internal control over financial reporting. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate. Leidos Holdings, Inc. Annual Report - 51 Table of Contents Goodwill Valuation – Security Products Reporting Unit - Refer to Note 3, Note 5 and Note 8 to the financial statements Critical Audit Matter Description The Company performed a quantitative impairment evaluation of the goodwill for the Security Products reporting unit by comparing the estimated fair value of the reporting unit to its carrying value. Estimating the fair value of a reporting unit 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. Changes in these assumptions could have a significant impact on the fair value of the reporting unit, the amount of any goodwill impairment charge, or both. The goodwill balance was $6,744 million as of December 31, 2021 of which $926 million related to the Security Products reporting unit. The Company’s accounting policy is to test for impairment on the first day of the fourth quarter of each year. As a result of the quantitative assessment, the Company concluded that the fair value of the reporting unit exceeded the carrying value by approximately 6%, which resulted in no impairment for the year ended December 31, 2021. Given the significant judgments made by management to estimate the fair value of the Security Products reporting unit and the difference between its fair value and carrying value, performing audit procedures to develop an independent estimate of the fair value of the Security Products reporting unit, which included evaluating estimates and assumptions related to the cost of capital, forecasts of future cash flows, and terminal growth rates specifically due to the sensitivity of the operations to changes in global aviation security products and related services markets, required a high degree of auditor judgment and an increased extent of effort, including the need to involve our fair value specialists. How the Critical Audit Matter Was Addressed in the Audit Our audit procedures related to the selection of the discount rate, terminal growth rate and forecasts of future revenues and cash flows for the Security Products reporting unit included the following, among others: • We tested the effectiveness of controls over management’s goodwill impairment evaluation, including those over the selection of the discount rate, terminal growth rate and management’s development of forecasts of future revenues and cash flows. • We developed an independent estimate of the fair value of the Security Products reporting unit using both the income as well as the market approach. We utilized historical results of the reporting unit and inspected third-party industry reports for the global aviation security products and related services markets to develop projections. Additionally, we developed the discount rate and terminal year growth rate with the assistance of our fair value specialists. • The market approach analysis was performed by selecting guideline peer companies and developing enterprise value multiples of revenues and Earnings Before Interest, Taxes, Depreciation and Amortization. We reconciled the results of the market approach with the discounted cash flow approach. • We evaluated the carrying value of the reporting unit. Revenues — Refer to Note 3 and Note 4 to the financial statements Critical Audit Matter Description The Company recognizes revenue on service-based contracts primarily over time as there is continuous transfer of control to the customer over the duration of the contract as the Company performs the promised services. The accounting conclusions for contracts involves judgment, particularly as it relates to determining whether multiple promises within a single contract are highly interrelated and represent a single performance obligation, and whether the Company is acting as a principal in the fulfillment of the identified performance obligations on certain contracts. Leidos Holdings, Inc. Annual Report - 52 Table of Contents On firm-fixed-price (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. The accounting for these contracts involves judgment, particularly as it relates to the process of estimating total costs for the performance obligation. Given the judgments necessary to determine whether multiple promises within a single contract represent a single performance obligation, whether or not the Company is acting as principal in the fulfillment of the identified performance obligations on certain contracts, and estimates of total costs for the performance obligations that recognize revenue using the cost-to-cost method, auditing such accounting conclusions and estimates required extensive audit effort due to the volume and complexity of these contracts and a high degree of auditor judgment when performing audit procedures and evaluating the results of those procedures. How the Critical Audit Matter Was Addressed in the Audit Our audit procedures related to management’s conclusions regarding whether multiple promises within a single contract represent a single performance obligation, whether or not the Company is acting as a principal or an agent in fulfilling identified performance obligations on certain contracts, and estimates of total costs for the performance obligations that recognize revenue using the cost-to-cost method included the following, among others: • We tested the effectiveness of controls over contract revenue, including management’s controls over the initial setup of new contract arrangements and the estimates of total costs for identified performance obligations. • We tested recorded revenue using a combination of analytical procedures and detailed contract testing. • For a selection of contracts, we performed elements of the following for each contract: ◦ Evaluated the terms and conditions of each contract and the appropriateness of the accounting treatment in accordance with generally accepted accounting principles, by: ▪ Inspecting the executed contract to verify that the facts on which management’s conclusions were reached were consistent with the actual terms and conditions of the contract. ▪ Evaluating the contract within the context of the five-step model prescribed by ASC 606 and that management’s conclusions were appropriate by evaluating the nature of the promises within the contract, the interrelationship of the promised services provided, the pattern by which obligations are fulfilled, the number of performance obligations identified, and which party is acting as principal in the fulfillment of the identified performance obligations. • Tested the mathematical accuracy of management’s calculation of revenue for the performance obligation. • We analyzed cumulative adjustments recorded during the year and tested those with characteristics of audit interest to determine that the adjustments were the result of changes in facts and circumstances and not estimates that were previously inaccurate. /s/ Deloitte & Touche LLP McLean, Virginia February 15, 2022 We have served as the Company's auditor since fiscal 2000. Leidos Holdings, Inc. Annual Report - 53 Table of Contents LEIDOS HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS December 31, 2021 January 1, 2021 (in millions) Assets: Cash and cash equivalents $ 727 $ 524 Receivables, net 2,189 2,137 Inventory, net 274 276 Other current assets 429 402 Total current assets 3,619 3,339 Property, plant and equipment, net 670 604 Intangible assets, net 1,177 1,216 Goodwill 6,744 6,313 Operating lease right-of-use assets, net 612 581 Other assets 439 458 Total assets $ 13,261 $ 12,511 Liabilities: Accounts payable and accrued liabilities $ 2,141 $ 2,175 Accrued payroll and employee benefits 605 632 Short-term debt and current portion of long-term debt 483 100 Total current liabilities 3,229 2,907 Long-term debt, net of current portion 4,593 4,644 Operating lease liabilities 589 564 Deferred tax liabilities 239 234 Other long-term liabilities 267 291 Total liabilities $ 8,917 $ 8,640 Commitments and contingencies (Notes 21) Stockholders’ equity: Preferred stock, $ 0.0001 par value, 10 million shares authorized and no shares issued and outstanding at December 31, 2021 and January 1, 2021 — — Common stock, $ 0.0001 par value, 500 million shares authorized, 140 million and 142 million shares issued and outstanding at December 31, 2021 and January 1, 2021, respectively — — Additional paid-in capital 2,423 2,580 Retained earnings 1,880 1,328 Accumulated other comprehensive loss ( 12 ) ( 46 ) Total Leidos stockholders’ equity 4,291 3,862 Non-controlling interest 53 9 Total stockholders' equity 4,344 3,871 Total liabilities and stockholders' equity $ 13,261 $ 12,511 See accompanying notes to consolidated financial statements. Leidos Holdings, Inc. Annual Report - 54 Table of Contents LEIDOS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF INCOME Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions, except per share amounts) Revenues $ 13,737 $ 12,297 $ 11,094 Cost of revenues 11,723 10,560 9,546 Selling, general and administrative expenses 860 770 689 Bad debt expense and recoveries ( 9 ) ( 68 ) ( 40 ) Acquisition, integration and restructuring costs 27 39 5 Asset impairment charges 4 12 — Equity earnings of non-consolidated subsidiaries ( 20 ) ( 14 ) ( 18 ) Operating income 1,152 998 912 Non-operating expense: Interest expense, net ( 184 ) ( 179 ) ( 133 ) Other (expense) income, net ( 1 ) ( 38 ) 87 Income before income taxes 967 781 866 Income tax expense ( 208 ) ( 152 ) ( 196 ) Net income 759 629 670 Less: net income attributable to non-controlling interest 6 1 3 Net income attributable to Leidos common stockholders $ 753 $ 628 $ 667 Earnings per share: Basic $ 5.34 $ 4.42 $ 4.66 Diluted 5.27 4.36 4.60 See accompanying notes to consolidated financial statements. Leidos Holdings, Inc. Annual Report - 55 Table of Contents LEIDOS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Net income $ 759 $ 629 $ 670 Foreign currency translation adjustments ( 8 ) 63 8 Unrecognized gain (loss) on derivative instruments 29 ( 37 ) ( 47 ) Pension adjustments 13 ( 2 ) ( 1 ) Total other comprehensive income (loss), net of taxes 34 24 ( 40 ) Comprehensive income 793 653 630 Less: comprehensive income attributable to non-controlling interest 6 1 3 Comprehensive income attributable to Leidos common stockholders $ 787 $ 652 $ 627 See accompanying notes to consolidated financial statements. Leidos Holdings, Inc. Annual Report - 56 Table of Contents LEIDOS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF EQUITY Shares of common stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Leidos Holdings, Inc. stockholders' equity Non-controlling interest Total (in millions, except for per share amounts) Balance at December 28, 2018 146 $ 2,966 $ 372 $ ( 30 ) $ 3,308 $ 3 $ 3,311 Cumulative adjustments related to ASU adoptions — — 48 — 48 — 48 Balance at December 28, 2018 146 2,966 420 ( 30 ) 3,356 3 3,359 Net income — — 667 — 667 3 670 Other comprehensive loss, net of taxes — — — ( 40 ) ( 40 ) — ( 40 ) Issuances of stock 1 28 — — 28 — 28 Repurchases of stock and other ( 6 ) ( 458 ) — — ( 458 ) — ( 458 ) Dividends of $ 1.32 per share — — ( 191 ) — ( 191 ) — ( 191 ) Stock-based compensation — 52 — — 52 — 52 Other — ( 1 ) — — ( 1 ) ( 2 ) ( 3 ) Balance at January 3, 2020 141 2,587 896 ( 70 ) 3,413 4 3,417 Cumulative adjustments related to ASU adoptions — — ( 1 ) — ( 1 ) — ( 1 ) Balance at January 4, 2020 141 2,587 895 ( 70 ) 3,412 4 3,416 Net income — — 628 — 628 1 629 Other comprehensive income, net of taxes — — — 24 24 — 24 Issuances of stock 1 36 — — 36 — 36 Repurchases of stock and other — ( 105 ) — — ( 105 ) — ( 105 ) Dividends of $ 1.36 per share — — ( 195 ) — ( 195 ) — ( 195 ) Stock-based compensation — 62 — — 62 — 62 Net capital contributions to non-controlling interest — — — — — 4 4 Balance at January 1, 2021 142 2,580 1,328 ( 46 ) 3,862 9 3,871 Net income — — 753 — 753 6 759 Other comprehensive income, net of taxes — — — 34 34 — 34 Issuances of stock 1 46 — — 46 — 46 Repurchases of stock and other ( 3 ) ( 270 ) — — ( 270 ) — ( 270 ) Dividends of $ 1.40 per share — — ( 201 ) — ( 201 ) — ( 201 ) Stock-based compensation — 67 — — 67 — 67 Net capital contributions to non-controlling interest — — — — — 38 38 Balance at December 31, 2021 140 $ 2,423 $ 1,880 $ ( 12 ) $ 4,291 $ 53 $ 4,344 See accompanying notes to consolidated financial statements. Leidos Holdings, Inc. Annual Report - 57 Table of Contents LEIDOS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Cash flows from operations: Net income $ 759 $ 629 $ 670 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization 325 282 234 Stock-based compensation 67 62 52 Loss (gain) on sale of businesses 3 — ( 88 ) Loss on debt extinguishment — 36 — Asset impairment charges 4 12 — Deferred income taxes ( 26 ) ( 4 ) 18 Bad debt expense and recoveries ( 9 ) 13 12 Other ( 1 ) 1 3 Change in assets and liabilities, net of effects of acquisitions and dispositions: Receivables ( 5 ) ( 127 ) 116 Other current assets and other long-term assets 143 104 41 Accounts payable and accrued liabilities and other long-term liabilities ( 212 ) 151 ( 71 ) Accrued payroll and employee benefits ( 32 ) 161 ( 29 ) Income taxes receivable/payable 15 14 34 Net cash provided by operating activities 1,031 1,334 992 Cash flows from investing activities: Acquisitions of businesses, net of cash acquired ( 622 ) ( 2,655 ) ( 94 ) Payments for property, equipment and software ( 104 ) ( 183 ) ( 121 ) Proceeds from disposition of businesses — — 178 Net proceeds from sale of assets — 12 96 Collections on promissory notes — 5 5 Other ( 4 ) 6 1 Net cash (used in) provided by investing activities ( 730 ) ( 2,815 ) 65 Cash flows from financing activities: Proceeds from debt issuance 380 7,225 — Payments of long-term debt ( 106 ) ( 5,456 ) ( 80 ) Payments for debt issuance and modification costs — ( 51 ) — Dividend payments ( 199 ) ( 196 ) ( 198 ) Repurchases of stock and other ( 270 ) ( 105 ) ( 458 ) Proceeds from issuances of stock 44 35 27 Capital distributions to non-controlling interests ( 3 ) — — Capital contributions from non-controlling interests 41 4 — Other — ( 5 ) — Net cash (used in) provided by financing activities ( 113 ) 1,451 ( 709 ) Net increase (decrease) in cash, cash equivalents and restricted cash 188 ( 30 ) 348 Cash, cash equivalents and restricted cash at beginning of year 687 717 369 Cash, cash equivalents and restricted cash at end of year 875 687 717 Leidos Holdings, Inc. Annual Report - 58 Table of Contents LEIDOS HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS [CONTINUED] Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Less: restricted cash at end of year 148 163 49 Cash and cash equivalents at end of year $ 727 $ 524 $ 668 Supplementary cash flow information: Cash paid for interest $ 182 $ 161 $ 172 Cash paid for income taxes, net of refunds 221 140 142 Non-cash investing activity: Property, plant and equipment additions $ 4 $ 18 $ 27 Non-cash financing activity: Finance lease obligations $ 51 $ 12 $ — See accompanying notes to consolidated financial statements. Leidos Holdings, Inc. Annual Report - 59 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1—Nature of Operations and Basis of Presentation Nature of Operations and Basis of Presentation Leidos Holdings, Inc. ("Leidos"), a Delaware corporation, is a holding company whose direct 100%-owned subsidiary and principal operating company is Leidos, Inc. Leidos is a FORTUNE 500 ® technology, engineering, and science company that provides services and solutions in the defense, intelligence, civil and health markets, both domestically and internationally. Leidos' customers include the U.S. Department of Defense ("DoD"), the U.S. Intelligence Community, the U.S. Department of Homeland Security, the Federal Aviation Administration, the Department of Veterans Affairs and many other U.S. civilian, state and local government agencies, foreign government agencies and commercial businesses. Unless indicated otherwise, references to "we," "us" and "our" refer collectively to Leidos Holdings, Inc. and its consolidated subsidiaries. We operate in three reportable segments: Defense Solutions, Civil and Health. Additionally, we separately present the unallocable costs associated with corporate functions as Corporate. We have 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 consolidate the financial results for MSA and HMIS into our consolidated financial statements. The consolidated financial statements also include the balances of all voting interest entities in which Leidos has a controlling voting interest ("subsidiaries") and a variable interest entity ("VIE") in which Leidos is the primary beneficiary. The consolidated balances of the VIE are not material to the consolidated financial statements for the periods presented. Intercompany accounts and transactions between consolidated companies have been eliminated in consolidation. 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. Effective the beginning of fiscal 2020, certain contracts were reassigned from the Civil reportable segment to the Defense Solutions reportable segment. Fiscal 2019 segment results and disclosures have been recast to reflect this change. Note 2—Accounting Standards Accounting Standards Updates Adopted ASU 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity's Own Equity (Subtopic 815-40) In August 2020, the Financial Accounting Standards Board ("FASB") issued ASU 2020-06 which simplifies the accounting for convertible debt and convertible preferred stock by removing the requirements to separate embedded conversion features from the host convertible instruments. Additionally, the amendments in this update simplify the guidance in Subtopic 815-40 by removing certain criteria that must be satisfied in order to classify a contract as equity. This update also improves the consistency of earnings per share calculations by requiring an entity to use the if-converted method of calculating diluted earnings per share rather than the treasury stock method for convertible instruments and also by requiring the inclusion of the potential effect of shares settled in cash or shares in the diluted earnings per share calculation. The amendments in this update are effective for public entities for fiscal years beginning after December 15, 2021, and adopted using either a fully or modified retrospective approach. Early adoption is permitted, but no earlier than fiscal years beginning after December 15, 2020. Entities should adopt the guidance as of the beginning of the fiscal year of adoption and cannot adopt the guidance in an interim reporting period. Effective January 2, 2021, we adopted the requirements of ASU 2020-06 using the modified retrospective method. The adoption did not have an impact to our financial position, results of operations and earnings per share. Leidos Holdings, Inc. Annual Report - 60 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ASU 2021-05, Leases (Topic 842) Lessors—Certain Leases with Variable Lease Payments In July 2021, the FASB issued ASU 2021-05, which amends lessor’s accounting for leases with variable lease payments classified as sales-type or direct financing leases. The amendments in this update modify the lease classification requirements for lessors, whereby leases with variable lease payments that are not dependent on a reference index or a rate will be accounted for as operating leases if classification as a sales-type or direct financing lease would have resulted in a day-one loss. The amendments in this update are effective for public entities for fiscal years beginning after December 15, 2021, as well as interim periods within those fiscal years, and can be adopted using either a prospective or retrospective approach. Early adoption is also permitted. Effective July 3, 2021, we adopted the requirements of ASU 2021-05 using the prospective method. The adoption did not have an impact to our financial position, results of operations and earnings per share. Accounting Standards Updates Issued But Not Yet Adopted ASU 2020-04 and ASU 2021-01, Reference Rate Reform (Topic 848) In March 2020, the FASB issued ASU 2020-04, which provides companies with optional expedients and exceptions to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. This update provides optional expedients for applying accounting guidance to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate ("LIBOR") or another reference rate expected to be discontinued because of the reference rate reform. The amendments in this update are effective for all entities as of March 2020 and can be adopted using a prospective approach no later than December 31, 2022. In January 2021, the FASB issued ASU 2021-01, which amends the scope of ASU 2020-04. The amendments in this update are elective and provide optional relief for entities with hedge accounting and contract modifications affected by the discounting transition through December 31, 2022. Under this relief, entities may continue to account for contract modifications as a continuation of the existing contract and the continuation of the hedge accounting arrangement. We are currently evaluating the impacts of reference rate reform. We currently use the one-month LIBOR for which the rate publication will cease in June 2023. ASU 2021-08, Business Combinations (Topic 805) In October 2021, the FASB issued ASU 2021-08, which amends how contract assets and liabilities acquired in a business combination are measured. Current guidance requires contract assets and liabilities to be measured at fair value in accordance with ASC 805, Business Combinations. The amendments in this Update remove the requirement to measure contract assets and liabilities at fair value and instead require that they be recognized in accordance with ASC 606, Revenue from Contracts with Customers. The amendments in this Update are effective for public business entities for the fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, and must be applied prospectively. Early adoption is permitted. We plan to adopt the requirements of ASU 2021-08 using the prospective method effective the first day of Fiscal 2022. For business combinations occurring after adoption, we will measure contract assets and liabilities acquired in accordance ASC 606 . Note 3—Summary of Significant Accounting Policies Reporting Periods Leidos' fiscal year ends on the Friday nearest the end of December. Fiscal 2021 ended December 31, 2021. Fiscal 2021 and 2020 each included 52 weeks and fiscal 2019 included 53 weeks. Leidos Holdings, Inc. Annual Report - 61 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Management evaluates these estimates and assumptions on an ongoing basis, including those relating to estimated profitability of long-term contracts, indirect billing rates, allowances for doubtful accounts, inventories, right-of-use ("ROU") assets and lease liabilities, fair value and impairment of intangible assets and goodwill, income taxes, pension benefits, stock-based compensation expense and contingencies. These estimates have been prepared by management on the basis of the most current and best available information; however, actual results could differ materially from those estimates. Operating Cycle Our operating cycle for long-term contracts may be greater than one year and is measured by the average time intervening between the inception and the completion of those contracts. Business Combinations, Investments and Variable Interest Entities Business Combinations The accounting for business combinations requires management to make judgments and estimates related to the fair value of assets acquired, including the identification and valuation of intangible assets, as well as liabilities and contingencies assumed. Such judgments and estimates directly impact the amount of goodwill recognized in connection with an acquisition. Estimating the fair value of acquired assets and assumed liabilities, including intangibles, requires judgments about expected future cash flows, weighted-average cost of capital, discount rates and expected long-term growth rates. Investments Investments in entities and corporate joint ventures where we have a non-controlling ownership interest but over which we have the ability to exercise significant influence, are accounted for under the equity method of accounting. We recognize our proportionate share of the entities' net income or loss and do not consolidate the entities' assets and liabilities. Equity investments in entities over which we do not have the ability to exercise significant influence and whose securities do not have a readily determinable fair value are carried at cost or cost net of other-than-temporary impairments. Variable Interest Entities We occasionally form joint ventures and/or enter into arrangements with special purpose limited liability companies for the purpose of bidding and executing on specific projects. We analyze each such arrangement to determine whether it represents a VIE. If the arrangement is determined to be a VIE, we assess whether we are the primary beneficiary of the VIE and are consequently required to consolidate the VIE. Divestitures From time-to-time, we may dispose (or management may commit to plans to dispose) of strategic or non-strategic components of the business. Divestitures representing a strategic shift that has (or will have) a major effect in operations and financial results are classified as discontinued operations, whereas non-strategic divestitures remain in continuing operations. Leidos Holdings, Inc. Annual Report - 62 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Restructuring Expenses Restructuring expenses are incurred in connection with programs aimed at reducing our costs. Restructuring costs may include one-time termination of benefits, costs to terminate contracts and other permanent exit costs to consolidate or close facilities directly related to the restructuring program. One-time involuntary termination benefits are recognized as a liability at estimated fair value when the plan of termination has been communicated to employees and certain other criteria are met. Ongoing termination benefit arrangements are recognized as a liability at estimated fair value when it is probable that amounts will be paid and such amounts are reasonably estimable. Costs associated with exit or disposal activities, including the related one-time and ongoing involuntary termination benefits, are included as "Acquisition, integration and restructuring costs" on the consolidated statements of income. 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 ("FP-IF") 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 indefinite delivery/indefinite quantity ("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. 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. 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 - 63 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. Substantially all of our contracts do not contain a significant financing component, which would require an adjustment to the transaction price of the contract. 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 generally 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. Contract Costs Contract costs generally include direct costs such as labor, materials, subcontract costs and indirect costs identifiable with or allocable to a specific contract. Costs are expensed as incurred unless they qualify for deferral and capitalization. Contract costs incurred for U.S. government contracts, including indirect costs, are subject to audit and adjustment by the Defense Contract Audit Agency ("DCAA") (see "Note 21—Commitments and Contingencies"). Pre-contract Costs Costs incurred on projects as pre-contract costs are deferred as assets when we have been requested by the customer to begin work under a new arrangement prior to contract execution and it is probable that we will recover the costs through the issuance of a contract. Pre-contract costs are amortized over the contract period of performance or a specified period of performance. Transition Costs Under certain service contracts, costs are incurred, usually at the beginning of the contract performance, to transition the services, employees and equipment to or from the customer, a prior contract or prior contractor. These costs are generally capitalized as deferred assets and amortized on a straight-line basis over the anticipated term of the contract or a specified period of performance, including unexercised option periods that are reasonably certain of being exercised. Leidos Holdings, Inc. Annual Report - 64 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Project Assets Purchases of project assets are capitalized for specific contracts where we maintain ownership of the asset over the life of the contract and the benefit is received over a period of time. Project assets include enterprise software licenses, dedicated hardware, maintenance agreements and significant material purchases and other costs incurred on contracts. Project assets are amortized from the balance sheet using the straight-line method over the estimated useful life of the asset or over the expected term of the period of performance, whichever is shorter. Changes in Estimates on Contracts Changes in estimates related to contracts accounted for using the cost-to-cost method of accounting are recognized in the period in which such changes are made for the inception-to-date effect of the changes, with the exception of contracts acquired through a business combination, where the adjustment is made for the period commencing from the date of acquisition. Changes in estimates on contracts for the periods presented were as follows: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions, except for per share amounts) Favorable impact $ 149 $ 137 $ 95 Unfavorable impact ( 102 ) ( 61 ) ( 52 ) Net favorable impact to income before income taxes $ 47 $ 76 $ 43 Impact on diluted EPS attributable to Leidos common stockholders $ 0.25 $ 0.39 $ 0.23 The impact on diluted earnings per share ("EPS") attributable to Leidos common stockholders is calculated using our statutory tax rate. Revenue Recognized from Prior Obligations During fiscal 2021, 2020 and 2019, revenue recognized from performance obligations satisfied in previous periods was $ 26 million, $ 40 million and $ 56 million, respectively. The changes primarily relate to revisions of variable consideration, including award and incentive fees, and revisions to estimates at completion resulting from changes in contract scope, mitigation of contract risks or due to true-ups of contract estimates at the end of contract performance. Selling, General and Administrative Expenses We classify indirect costs incurred within or allocated to our U.S. government customers as overhead (included in "Cost of revenues") or general and administrative expenses in the same manner as such costs are defined in our disclosure statements under U.S. government Cost Accounting Standards. Selling, general and administrative expenses include general and administrative, bid and proposal and company-funded research and development expenses. We conduct research and development activities under customer-funded contracts and with company-funded research and development funds. Company-funded research and development expense was $ 109 million, $ 73 million and $ 49 million for fiscal 2021, 2020 and 2019, respectively. Expenses for research and development activities performed under customer contracts are charged directly to cost of revenues for those contracts. Income Taxes 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. Leidos Holdings, Inc. Annual Report - 65 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. Cash and Cash Equivalents Our cash equivalents are primarily comprised of investments in several large institutional money market accounts, with original maturity of three months or less. Outstanding payments are included within "Cash and cash equivalents" and "Accounts payable and accrued liabilities" correspondingly on the consolidated balance sheets. At December 31, 2021 and January 1, 2021, $ 138 million and $ 237 million, respectively, of outstanding payments were included within "Cash and cash equivalents." Restricted Cash We have restricted cash balances, primarily representing advances from customers that are restricted as to use for certain expenditures related to that customer's contract. Restricted cash balances are included as "Other current assets" on the consolidated balance sheets. Our restricted cash balances were $ 148 million and $ 163 million at December 31, 2021 and January 1, 2021, respectively. Receivables Receivables include amounts billed and currently due from customers, amounts billable where the right to consideration is unconditional and amounts unbilled. Amounts billable and unbilled amounts are recognized at estimated realizable value and consist of costs and fees, substantially all of which are expected to be billed and collected generally within one year. Unbilled amounts also include rate variances that are billable upon negotiation of final indirect rates with the DCAA. Cost-reimbursable and T&M contracts are generally billed as costs are incurred. FFP contracts are billed either based on milestones, which are the achievement of specific events as defined in the contract, or based on progress payments, which are interim payments up to a designated amount of costs incurred as work progresses. On certain contracts, the customer withholds a certain percentage of the contract price (retainage). These withheld amounts are included within unbilled receivables and are billed upon contract completion or the occurrence of a specified event, and when negotiation of final indirect rates with the U.S. government is complete. Based on our historical experience, the write-offs of retention balances have not been significant. When events or conditions indicate that amounts outstanding from customers may become uncollectible, an allowance is estimated and recorded. Amounts billed and collected on contracts but not yet recorded as revenue because we have not performed our obligation under the arrangement with a customer are deferred and included within "Accounts payable and accrued liabilities" or "Other long-term liabilities" on the consolidated balance sheets. Leidos Holdings, Inc. Annual Report - 66 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Concentration of Credit Risk Financial instruments that potentially subject us to concentrations of credit risk primarily consist of accounts receivable and derivatives. Since our receivables are primarily with the U.S. government, we do not have exposure to a material credit risk. We manage our credit risk related to derivatives through the use of multiple counterparties with high credit standards. Inventories Inventories are valued at the lower of cost or estimated net realizable value. Generally, raw material inventory is valued using the average cost method. Work-in-process inventory includes raw material costs plus labor costs, including fringe benefits and allocable overhead costs. The majority of finished goods inventory consists of technology and security products, inspection systems, baggage scanning equipment and small glide munitions. Inventory is evaluated against historical and planned usage to determine appropriate provisions for obsolete inventory. Goodwill 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. 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 both fiscal 2021 and 2020, we had seven reporting units for the purpose of testing goodwill for impairment. Goodwill is evaluated for impairment either under a qualitative assessment option or a quantitative approach, which depends on the facts and circumstances of a reporting unit, consideration of the excess of a reporting unit's fair value over its carrying amount in previous assessments and changes in business environment. When performing a qualitative assessment, we consider factors including, but not limited to, current macroeconomic conditions, industry and market conditions, cost factors, financial performance and other events relevant to the entity or reporting unit under evaluation to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If we determine that it is more likely than not that a reporting unit's fair value is less than its carrying amount, a quantitative goodwill impairment test is performed. When performing a quantitative goodwill impairment test, the reporting unit carrying value is compared to its fair value. Goodwill is deemed impaired if, and the impairment loss is recognized for the amount by which, the reporting unit carrying value exceeds its fair value. We estimate the fair value of each reporting unit using Level 3 inputs when a quantitative analysis is performed. These analyses rely on significant judgements and assumptions about expected future cash flows, weighted-average cost of capital, discount rates, expected long-term growth rates, operating margins and on the selection of guideline public companies. Leidos Holdings, Inc. Annual Report - 67 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Intangible Assets Acquired intangible assets with finite lives and internally developed software are amortized using the method that best reflects how their economic benefits are utilized or, if a pattern of economic benefits cannot be reliably determined, on a straight-line basis over their estimated useful lives. Program intangible assets are amortized over their respective estimated useful lives in proportion to the pattern of economic benefit based on expected future discounted cash flows. Backlog and trade name intangible assets are amortized on a straight-line basis over their estimated useful lives. Customer relationships and software and technology intangible assets are amortized either on a straight-line basis over their estimated useful lives or over their respective estimated useful lives in proportion to the pattern of economic benefit based on expected future discounted cash flows, as deemed appropriate. Intangible assets with finite lives are amortized over the following periods: Estimated useful lives (in years) Backlog 1 Customer relationships 8 - 10 Programs 4 - 13 Software and technology 3 - 15 Trade names 3 Intangible assets with finite lives are assessed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. 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. Property, Plant and Equipment Purchases of property, plant and equipment, including purchases of software and software licenses, as well as costs associated with major renewals and improvements are capitalized. Maintenance, repairs and minor renewals and improvements are expensed as incurred. Construction in Progress ("CIP") is used to accumulate all costs for projects that are not yet complete. CIP balances are transferred to the appropriate asset account when the asset is capitalized and ready for its intended use. When assets are sold or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts and any resulting gain or loss is recognized. Depreciation is recognized using the methods and estimated useful lives as follows: Depreciation method Estimated useful lives (in years) Computers and other equipment Straight-line or declining-balance 2 - 15 Buildings Straight-line Not to exceed 40 Building improvements and leasehold improvements Straight-line Shorter of useful life of asset or remaining lease term Office furniture and fixtures Straight-line or declining-balance 6 - 9 We evaluate our long-lived assets for potential impairment whenever there is evidence that events or changes in circumstances indicate that the carrying value may not be recoverable and the carrying amount of the asset exceeds its estimated fair value. Leases Lessee We have facilities and equipment lease arrangements. An arrangement is determined to be a lease at inception if it conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. Right-of-use ("ROU") assets represent the right to use an underlying asset over the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Leidos Holdings, Inc. Annual Report - 68 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ROU assets and lease liabilities are recorded on the consolidated balance sheet at lease commencement date based on the present value of the future minimum lease payments over the lease term. We generally do not know the implicit rate for our leases; therefore, the discount rate used is our incremental borrowing rate which is determined based on the rate of interest that we would have to pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. An ROU asset is initially measured by the present value of the remaining lease payments, plus initial direct costs and prepaid lease payments, less any lease incentives received before commencement. The remaining lease cost is allocated over the remaining lease term on a straight-line basis unless another systematic or rational basis is more representative of the pattern in which the underlying asset is expected to be used. ROU assets are evaluated for impairment in a manner consistent with the treatment of other long-lived assets. Certain facility leases contain options to renew or extend the terms of the lease which are included in the determination of the ROU assets and lease liabilities when it is reasonably certain that we will exercise the option. Leases may also include variable lease payments such as an escalation clause based on consumer price index rates, maintenance costs and utilities. Variable lease payments that depend on an index or a rate are included in the determination of ROU assets and lease liabilities using the index or rate at the lease commencement date, whereas variable lease payments that do not depend on an index or rate are recorded as lease expense in the period incurred. At December 31, 2021, we did not have any lease agreements with residual value guarantees. We use the practical expedient to not separate non-lease components from lease components and instead account for both components as a single lease. The practical expedient is applied to all material classes of leased assets except for aircrafts, for which we account for the lease component and non-lease component separately. The related lease payments on short-term facilities and equipment leases are recognized as expense on a straight-line basis over the lease term. ROU assets are assessed for potential impairment whenever there is evidence that events or changes in circumstances indicate that the carrying value of the asset may not be recoverable and the carrying amount of the asset exceeds its estimated fair value. This includes an establishment of a plan of abandonment, which occurs when we have committed to a plan to abandon the lease before the end of its previously estimated useful life and there is no expectation that we will re-enter or re-purpose the space, including the fact that it cannot be subleased or transferred to another program within Leidos. Lessor We are a lessor on certain equipment sales-type and operating lease arrangements with our customers. To be considered lease revenue, the contract must contain a specified asset, we must not have a substantive substitution right, the customer must have the right to direct the use of the specified asset during the period of use and the customer must have the right to obtain substantially all of the economic benefit of the specified asset. Certain arrangements may contain variable payments that depend on an index or rate and are measured using the index or rate on the commencement date. Variable payments that are not included in the net investments are recorded as revenue as incurred. Arrangements may also contain options to renew or extend the performance period. Option periods are included in the lease term if we determine that it is reasonably certain the customer will exercise an option. We have arrangements that contain both lease and non-lease components. We account for them as one unit of account if the timing and pattern of transfer is identical for both the lease and the non-lease components and the lease component would be classified as an operating lease if accounted for separately. If both criteria are met and the predominant component is a lease, then the entire arrangement will be accounted for in accordance with ASC 842. If we account for an arrangement both as a lease and non-lease component, then the allocation of consideration for each component will be based the relative standalone sales price. Leidos Holdings, Inc. Annual Report - 69 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair Value Measurements The accounting standard for fair value measurements establishes a three-level fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: observable inputs such as quoted prices in active markets (Level 1); inputs other than quoted prices in active markets for identical assets or liabilities that are observable either directly or indirectly or quoted prices that are not active (Level 2); and unobservable inputs in which there is little or no market data (e.g., discounted cash flow and other similar pricing models), which requires us to develop our own assumptions about the assumptions that market participants would use in pricing the asset or liability (Level 3). The accounting guidance for fair value measurements requires that we maximize the use of observable inputs and minimize the use of unobservable inputs in determining fair value. The accounting guidance provides for the irrevocable option to elect, on a contract-by-contract basis, to measure certain financial assets and liabilities at fair value at inception of the contract and record any subsequent changes in fair value in earnings. We have not made fair value option elections on any of our financial assets and liabilities. The fair value of financial instruments is determined based on quoted market prices, if available, or management's best estimate (see "Financial Instruments" below). Management evaluates its investments for other-than-temporary impairment at each balance sheet date. When testing long-term investments for recovery of carrying value, the fair value of long-term investments is determined using various valuation techniques and factors, such as market prices of comparable companies (Level 2 input), discounted cash flow models (Level 3 input). If management determines that an other-than-temporary decline in the fair value of an investment has occurred, an impairment loss is recognized to reduce the investment to its estimated fair value. Our non-financial instruments measured at fair value on a non-recurring basis include goodwill, indefinite-lived intangible assets and long-lived tangible assets. The valuation methods used to determine fair value require a significant degree of management judgment to determine the key assumptions. As such, we generally classify non-financial instruments as either Level 2 or Level 3 fair value measurements. Financial Instruments We are exposed to certain market risks which are inherent in certain transactions entered into during the normal course of business. These transactions include sales or purchase contracts denominated in foreign currencies and exposure to changing interest rates. We manage our risk to changes in interest rates and foreign currency exchange rates through the use of derivative instruments. For fixed rate borrowings, we use variable interest rate swaps, effectively converting fixed rate borrowings to variable rate borrowings. These swaps are designated as fair value hedges. The fair value of these interest rate swaps is determined based on observed values for underlying interest rates on the LIBOR yield curve (Level 2). For variable rate borrowings, we use fixed interest rate swaps, effectively converting a portion of the variable interest rate payments to fixed interest rate payments. These swaps are designated as cash flow hedges. The fair value of these interest rate swaps is determined based on observed values for the underlying interest rates (Level 2). We enter into foreign currency forward contracts in order to mitigate fluctuations in our earnings and cash flows due to changes in foreign currency exchange rates. The foreign currency forward contracts are not designated as hedges and hedge accounting does not apply. We do not hold derivative instruments for trading or speculative purposes. Our defined benefit plan assets consist of investments in pooled funds that contain investments with values based on quoted market prices, but for which the pools are not valued on a daily quoted market basis (Level 2). Stock-Based Compensation We account for stock-based compensation at the grant date based on the fair value of the award and recognize expense over the requisite service period, which is generally the vesting period, net of an estimated forfeiture rate. The fair value of restricted stock awards and performance-based stock awards is based on the closing price of Leidos common stock on the date of grant. The fair value of performance-based stock awards with market conditions is based on using a Monte Carlo simulation. Leidos Holdings, Inc. Annual Report - 70 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair value of stock option awards granted is based on using the Black-Scholes-Merton option pricing model. The estimation of stock option fair value requires management to make estimates and judgments about, among other things, employee exercise behavior, forfeiture rates and the expected volatility of Leidos common stock over the expected option term. These judgments directly affect the amount of compensation expense that will ultimately be recognized. Foreign Currency The financial statements of consolidated international subsidiaries, for which the functional currency is not the U.S. dollar, are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities and a weighted average exchange rate over the reporting period for revenues, expenses, gains and losses. Translation adjustments are recorded as accumulated other comprehensive loss in stockholders' equity. Gains and losses due to movements in foreign currency exchange rates are recognized as "Other (expense) income, net" on the consolidated statements of income. Note 4—Revenues Remaining Performance Obligations Remaining performance obligations represent the expected value of exercised contracts, both funded and unfunded, less revenue recognized to date. Remaining performance obligations do not include unexercised option periods and future potential task orders expected to be awarded under IDIQ contracts, General Services Administration Schedule or other master agreement contract vehicles, with the exception of certain IDIQ contracts where task orders are not competitively awarded and separately priced but instead are used as a funding mechanism, and where there is a basis for estimating future revenues and funding on future anticipated task orders. As of December 31, 2021, we had $ 15.6 billion of remaining performance obligations and expect to recognize approximately 53 % and 71 % over the next 12 months and 24 months, respectively, with the remaining to be recognized thereafter. Disaggregation of Revenues We disaggregate revenues by customer-type, contract-type and geographic location for each of our reportable segments. These categories represent how the nature, timing and uncertainty of revenues and cash flows are affected. Fiscal 2019 amounts have been recast for certain contracts that were reassigned from the Civil reportable segment to the Defense Solutions reportable segment (see "Note 20—Business Segments"). Leidos Holdings, Inc. Annual Report - 71 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Disaggregated revenues by customer-type were as follows: Year Ended December 31, 2021 Defense Solutions Civil Health Total (in millions) DoD and U.S. Intelligence Community $ 5,939 $ 54 $ 756 $ 6,749 Other government agencies (1) 964 2,447 1,681 5,092 Commercial and non-U.S. customers 1,126 543 107 1,776 Total $ 8,029 $ 3,044 $ 2,544 $ 13,617 Year Ended January 1, 2021 Defense Solutions Civil Health Total (in millions) DoD and U.S. Intelligence Community $ 5,407 $ 59 $ 519 $ 5,985 Other government agencies (1) 995 2,418 1,329 4,742 Commercial and non-U.S. customers 937 426 107 1,470 Total $ 7,339 $ 2,903 $ 1,955 $ 12,197 Year Ended January 3, 2020 Defense Solutions Civil Health Total (in millions) DoD and U.S. Intelligence Community $ 4,767 $ 67 $ 491 $ 5,325 Other government agencies (1) 685 2,291 1,332 4,308 Commercial and non-U.S. customers 847 345 151 1,343 Total $ 6,299 $ 2,703 $ 1,974 $ 10,976 (1) Includes federal government agencies other than the DoD and U.S. Intelligence Community, as well as state and local government agencies. The majority of our revenues are generated from U.S. government contracts, either as a prime contractor or as a subcontractor to other contractors. Revenues from the U.S. government can be adversely impacted by spending caps or changes in budgetary priorities of the U.S. government, as well as delays in program start dates or the award of a contract. Disaggregated revenues by contract-type were as follows: Year Ended December 31, 2021 Defense Solutions Civil Health Total (in millions) Cost-reimbursement and fixed-price-incentive-fee $ 4,792 $ 1,576 $ 508 $ 6,876 Firm-fixed-price 2,290 1,020 1,661 4,971 Time-and-materials and fixed-price-level-of-effort 947 448 375 1,770 Total $ 8,029 $ 3,044 $ 2,544 $ 13,617 Year Ended January 1, 2021 Defense Solutions Civil Health Total (in millions) Cost-reimbursement and fixed-price-incentive-fee $ 4,504 $ 1,411 $ 280 $ 6,195 Firm-fixed-price 2,067 1,061 1,303 4,431 Time-and-materials and fixed-price-level-of-effort 768 431 372 1,571 Total $ 7,339 $ 2,903 $ 1,955 $ 12,197 Leidos Holdings, Inc. Annual Report - 72 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year Ended January 3, 2020 Defense Solutions Civil Health Total (in millions) Cost-reimbursement and fixed-price-incentive-fee $ 4,070 $ 1,624 $ 234 $ 5,928 Firm-fixed-price 1,642 636 1,296 3,574 Time-and-materials and fixed-price-level-of-effort 587 443 444 1,474 Total $ 6,299 $ 2,703 $ 1,974 $ 10,976 Cost-reimbursement and FP-IF contracts are generally lower risk and have lower profits. T&M and FP-LOE contracts are also lower risk but profits may vary depending on actual labor costs compared to negotiated contract billing rates. FFP contracts offer the potential for higher profits while increasing the exposure to risk of cost overruns. Disaggregated revenues by geographic location were as follows: Year Ended December 31, 2021 Defense Solutions Civil Health Total (in millions) United States $ 7,045 $ 2,880 $ 2,544 $ 12,469 International 984 164 — 1,148 Total $ 8,029 $ 3,044 $ 2,544 $ 13,617 Year Ended January 1, 2021 Defense Solutions Civil Health Total (in millions) United States $ 6,501 $ 2,738 $ 1,955 $ 11,194 International 838 165 — 1,003 Total $ 7,339 $ 2,903 $ 1,955 $ 12,197 Year Ended January 3, 2020 Defense Solutions Civil Health Total (in millions) United States $ 5,494 $ 2,632 $ 1,974 $ 10,100 International 805 71 — 876 Total $ 6,299 $ 2,703 $ 1,974 $ 10,976 Our international business operations, primarily located in Australia and the U.K., are subject to additional and different risks than our U.S. business. Failure to comply with U.S. government laws and regulations applicable to international business, such as the Foreign Corrupt Practices Act or U.S. export control regulations, could have an adverse impact on our business with the U.S. government. In some countries, there is an increased chance for economic, legal or political changes that may adversely affect the performance of our services, sales of products or repatriation of profits. International transactions can also involve increased financial and legal risks arising from foreign exchange variability, imposition of tariffs or additional taxes and restrictive trade policies and delays or failure to collect amounts due to differing legal systems. Revenues by contract-type, customer-type and geographic location exclude lease income of $ 120 million, $ 100 million and $ 118 million for fiscal 2021, 2020 and 2019, respectively (see "Note 10—Leases"). Leidos Holdings, Inc. Annual Report - 73 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Contract Assets and Liabilities Performance obligations are satisfied either over time as work progresses or at a point in time. Firm-fixed-price contracts are typically billed to the customer using milestone payments while cost-reimbursable and time and materials contracts are typically billed to the customer on a monthly or bi-weekly basis as indicated by the negotiated billing terms and conditions of the contract. As a result, the timing of revenue recognition, customer billings and cash collections for each contract results in a net contract asset or liability at the end of each reporting period. Contract assets consist of unbilled receivables, which is the amount of revenue recognized that exceeds the amount billed to the customer, where right to payment is not solely subject to the passage of time. Unbilled receivables exclude amounts billable where the right to consideration is unconditional. Contract liabilities consist of deferred revenue, which represents cash advances received prior to performance for programs and billings in excess of revenue recognized. The components of contract assets and contract liabilities consisted of the following: Balance sheet line item December 31, 2021 January 1, 2021 (in millions) Contract assets - current: Unbilled receivables Receivables, net $ 1,022 $ 906 Contract liabilities - current: Deferred revenue (1) Accounts payable and accrued liabilities $ 364 $ 481 Contract liabilities - non-current: Deferred revenue (1) Other long-term liabilities $ 24 $ 20 (1) Certain contracts record revenue on a net contract basis, and therefore, the respective deferred revenue balance will not fully convert to revenue. The increase in unbilled receivables was primarily due to revenue recognized on certain contracts partially offset by the timing of billings. The decrease in deferred revenue was primarily due to the timing of advance payments and revenue recognized during the period. Revenue recognized during fiscal 2021 and 2020 of $ 340 million and $ 275 million, respectively, was included as a contract liability at January 1, 2021 and January 3, 2020, respectively. There were no impairment losses recognized on contract assets during fiscal 2021, 2020 and 2019. Note 5—Acquisitions and Divestitures Acquisitions We may acquire businesses as part of our growth strategy to provide new or enhance existing capabilities and offerings to customers. During fiscal 2021, we completed the acquisitions of Gibbs & Cox, 1901 Group, LLC ("1901 Group"), and an immaterial strategic acquisition. During fiscal 2020, we completed the acquisitions of L3Harris Technologies' security detection and automation businesses (the "SD&A Businesses") and Dynetics, Inc. ("Dynetics"). During fiscal 2019, we completed the acquisition of IMX Medical Management Services, Inc. and its affiliated businesses ("IMX"). Leidos Holdings, Inc. Annual Report - 74 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Gibbs & Cox Acquisition On May 7, 2021 (the "Purchase Date"), we completed the acquisition of Gibbs & Cox for purchase consideration of approximately $ 375 million, net of $ 1 million of cash acquired. Gibbs & Cox is an independent engineering and design firm specializing in naval architecture, marine engineering, management support and engineering consulting. The preliminary goodwill recognized of $ 276 million represents intellectual capital and the acquired assembled workforce, neither of which qualify for recognition as a separate intangible asset. All of the goodwill recognized is tax deductible. The following table summarizes the fair value of intangible assets acquired at the Purchase Date and the related weighted average amortization period: Weighted average amortization period Fair value (in years) (in millions) Programs 12 $ 89 As of December 31, 2021, we had not finalized the determination of fair values allocated to assets and liabilities, including, but not limited to accounts receivables and accounts payable and accrued liabilities. 1901 Group Acquisition On January 14, 2021 (the "Closing Date"), we completed the acquisition of 1901 Group for purchase consideration of $ 212 million, net of $ 2 million of cash acquired. As of December 31, 2021, we had completed the determination of fair values of the acquired assets and liabilities assumed. The final goodwill recognized of $ 123 million represents intellectual capital and the acquired assembled workforce, none of which qualify for recognition as separate intangible assets. Of the goodwill recognized, $ 118 million is tax deductible. The following table summarizes the fair value of intangible assets acquired at the Closing Date and the related weighted average amortization period: Weighted average amortization period Fair value (in years) (in millions) Technology 8 $ 43 Programs 10 37 Backlog 1 6 Total 8 $ 86 For fiscal 2021, $ 145 million of revenues related to the Gibbs & Cox and 1901 Group acquisitions were recognized within the Defense Solutions reportable segmen t. On September 21, 2021, we completed an immaterial strategic business acquisition for preliminary purchase consideration of approximately $ 36 million. In connection with the transaction, the Company recognized an $ 8 million program intangible asset and preliminary goodwill of $ 24 million. SD&A Businesses Acquisition On May 4, 2020 (the "Transaction Date"), we completed the acquisition of the SD&A Businesses. The SD&A Businesses were acquired for cash consideration of $ 1,019 million, net of $ 27 million of cash acquired. The purchase consideration includes the initial cash payment of $ 1,015 million plus a $ 31 million payment for contractual net working capital acquired. The SD&A Businesses provide airport and critical infrastructure screening products, automated tray return systems and other industrial automation products. The addition of the SD&A Businesses will expand the scope and scale of our global security detection and automation offerings. Leidos Holdings, Inc. Annual Report - 75 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The final fair values of the assets acquired and liabilities assumed at the Transaction Date were as follows (in millions): Cash $ 27 Receivables 128 Inventory 106 Other current assets 26 Operating lease right-of-use assets 35 Property, plant and equipment 32 Intangible assets 355 Accounts payable and accrued liabilities ( 132 ) Accrued payroll and employee benefits ( 8 ) Operating lease liabilities ( 32 ) Deferred tax liabilities ( 52 ) Other long-term liabilities ( 13 ) Total identifiable net assets acquired 472 Goodwill 574 Purchase price $ 1,046 As of May 4, 2021, we had completed the determination of fair values of the acquired assets and liabilities assumed. The goodwill represents intellectual capital and the acquired assembled workforce. Of the goodwill recognized, $ 432 million is deductible for tax purposes. The following table summarizes the final fair value of intangible assets acquired at the Transaction Date and the related weighted average amortization period: Weighted average amortization period Fair value (in years) (in millions) Programs 13 $ 141 Customer relationships 10 49 Technology 10 73 In-process research and development ("IPR&D") (1) 92 Total 11 $ 355 (1) IPR&D assets are indefinite-lived at the acquisition date until placed into service, at which time such assets will be reclassified to a finite-lived amortizable intangible asset. For fiscal 2021 and fiscal 2020, $ 291 million and $ 243 million, respectively, of revenues related to the SD&A Businesses were recognized within the Civil reportable segment. Dynetics Acquisition On January 31, 2020 (the "Acquisition Date"), we completed our acquisition of Dynetics, an industry-leading applied research and national security solutions company. The addition of Dynetics will accelerate opportunities within our innovation engine that researches and develops new technologies and solutions to address the most challenging needs of our customers. All of the issued and outstanding shares of common stock of Dynetics were purchased for $ 1.64 billion, net of cash acquired. Leidos Holdings, Inc. Annual Report - 76 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The final fair values of the assets acquired and liabilities assumed at the Acquisition Date were as follows (in millions): Cash $ 18 Receivables 158 Inventory 47 Other current assets 18 Operating lease right-of-use assets 25 Property, plant and equipment 172 Intangible assets 528 Other assets 8 Accounts payable and accrued liabilities ( 50 ) Accrued payroll and employee benefits ( 29 ) Operating lease liabilities ( 20 ) Other long-term liabilities ( 4 ) Total identifiable net assets acquired 871 Goodwill 789 Purchase price $ 1,660 As of January 31, 2021, we had completed the determination of fair values of the acquired assets and liabilities assumed. The goodwill represents intellectual capital and the acquired assembled workforce. All of the goodwill recognized is deductible for tax purposes. The following table summarizes the final fair value of intangible assets acquired at the Acquisition Date and the related weighted average amortization period: Weighted average amortization period Fair value (in years) (in millions) Programs 13 $ 485 Backlog 1 32 Technology 11 11 Total 12 $ 528 For fiscal 2021 and fiscal 2020, $ 1,065 million and $ 937 million, respectively, of revenues related to Dynetics were recognized within the Defense Solutions reportable segment. IMX Acquisition On August 15, 2019, we completed the acquisition of IMX for purchase consideration of $ 94 million. The acquisition extends our independent medical evaluation coverage area for commercial and federal customers. We recorded $ 50 million of goodwill, which is deductible for tax purposes, and $ 42 million of intangible assets. The intangible assets primarily consist of $ 41 million for customer relationships. The amortization period for the customer relationships is 10 years. Leidos Holdings, Inc. Annual Report - 77 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Acquisition and Integration Costs The following expenses were incurred related to the acquisitions of Dynetics, the SD&A Businesses, 1901 Group and Gibbs & Cox: Year Ended December 31, 2021 January 1, 2021 (in millions) Acquisition costs $ 4 $ 23 Integration costs 20 12 Total acquisition and integration costs $ 24 $ 35 These acquisition and integration costs have been primarily recorded within Corporate and presented in "Acquisition, integration and restructuring costs" on the consolidated statement of income. Divestitures Aviation & Missile Solutions LLC ("AMS") On November 22, 2021, we signed a definitive agreement within our Defense Solutions segment to dispose of its AMS business in order to focus on leading-edge and technologically advanced services, solutions and products. The sales price will be approximately $ 18 million, subject to certain adjustments and is expected to be completed during fiscal year 2022. Health Staff Augmentation Business On September 12, 2019, our Health segment disposed of its health staff augmentation business that was primarily focused on implementation and optimization services to hospital centers. During the quarter ended January 3, 2020, working capital adjustments were finalized, resulting in a final sales price of $ 13 million. This consideration included $ 12 million of cash proceeds and expenses the buyer paid on Leidos' behalf. Net assets of $ 12 million were divested. This disposition did not meet the criteria to be classified as a discontinued operation in the financial statements. Commercial Cybersecurity Business On February 20, 2019, our Civil segment disposed of its commercial cybersecurity business in order to focus on providing solutions, including cybersecurity, to our core markets of governments and highly regulated industries. The commercial cybersecurity business was divested for a final sales price of $ 166 million. A pre-tax gain on sale of $ 88 million was recorded, net of $ 68 million of assets divested and $ 10 million in transaction related costs. The net assets divested included $ 14 million of receivables, $ 57 million of goodwill and $ 13 million of accounts payable and accrued liabilities. The gain was recorded in "Other (expense) income, net" on the consolidated statements of income. This disposition did not meet the criteria to be classified as a discontinued operation in the financial statements. Leidos Holdings, Inc. Annual Report - 78 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 6—Receivables The components of receivables, net consisted of the following: December 31, 2021 January 1, 2021 (in millions) Billed and billable receivables $ 1,194 $ 1,270 Unbilled receivables 1,022 906 Allowance for doubtful accounts ( 27 ) ( 39 ) $ 2,189 $ 2,137 Sale of Accounts Receivable We have entered into purchase agreements with a financial institution which provide us the election to sell accounts receivable at a discount. The receivables sold are typically collectable from our customers within 30 days of the sale date. During fiscal 2021 and 2020, we sold $ 693 million and $ 1,866 million, respectively, of accounts receivable under the agreements and received proceeds of $ 693 million and $ 1,864 million, respectively. These activities are classified as operating activities in the consolidated statements of cash flows. These transfers have been recognized as a sale, as the receivables have been legally isolated from Leidos, the financial institution has the right to pledge or exchange the assets received and we do not maintain effective control over the transferred accounts receivable. The difference between the carrying amount of the receivables sold and the net cash received was recognized as a loss on sale and was recorded within "Selling, general and administrative expenses" on the consolidated statements of income. As of December 31, 2021 and January 1, 2021, all sold receivables had been remitted to the financial institution. Note 7—Inventory The components of inventory, net consisted of the following: December 31, 2021 January 1, 2021 (in millions) Raw materials $ 154 $ 136 Work in process 27 41 Finished goods 93 99 $ 274 $ 276 Leidos Holdings, Inc. Annual Report - 79 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 8—Goodwill and Intangible Assets Goodwill The following table presents changes in the carrying amount of goodwill by reportable segment: Defense Solutions Civil Health Total (in millions) Goodwill at January 3, 2020 (1) $ 2,039 $ 1,907 $ 966 $ 4,912 Goodwill re-allocation 429 ( 429 ) — — Acquisitions of businesses 788 569 — 1,357 Foreign currency translation adjustments 44 — — 44 Goodwill at January 1, 2021 (1) 3,300 2,047 966 6,313 Acquisitions of businesses 425 5 — 430 Divestiture of a business ( 1 ) — — ( 1 ) Goodwill re-allocation ( 17 ) 17 — — Foreign currency translation adjustments ( 26 ) 28 — 2 Goodwill at December 31, 2021 (1) $ 3,681 $ 2,097 $ 966 $ 6,744 (1) Carrying amount includes accumulated impairment losses of $ 369 million and $ 117 million within the Health and Civil segments, respectively. Effective the beginning of fiscal 2020, certain contracts were reassigned from the Civil reportable segment to the Defense Solutions reportable segment (see "Note 20—Business Segments"). This change resulted in the reallocation of $ 429 million of goodwill between the reporting units within the two reportable segments. We evaluated goodwill for impairment for certain reporting units using either a quantitative step one analysis or qualitative analysis, both before and after the changes were made, and determined that goodwill was no t impaired. In the fourth quarter of fiscal 2021, we performed a qualitative analysis for certain reporting units which determined that it was more likely than not that the fair values of these reporting units were in excess of the individual reporting units' carrying values. For reporting units whose composition was affected by a reorganization, or those for which an indication of impairment exists, a quantitative assessment was performed. The quantitative analysis for the Security Products reporting unit within the Civil reportable segment, which holds goodwill in the amount of $ 926 million as of December 31, 2021, showed that the fair value of the 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. In the fourth quarter of fiscal 2020 and 2019, we performed a qualitative analysis for all reporting units and determined that it was more likely than not that the fair values of the reporting units were in excess of the individual reporting units carrying values, and as a result, a quantitative step one analysis was not necessary. As a result, no goodwill impairments were identified as part of the annual goodwill impairment evaluation for the periods mentioned above. Leidos Holdings, Inc. Annual Report - 80 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Intangible Assets Intangible assets, net consisted of the following: December 31, 2021 January 1, 2021 Gross carrying value Accumulated amortization Net carrying value Gross carrying value Accumulated amortization Net carrying value (in millions) Finite-lived intangible assets: Programs $ 1,722 $ ( 830 ) $ 892 $ 1,632 $ ( 687 ) $ 945 Software and technology 230 ( 121 ) 109 188 ( 100 ) 88 Customer relationships 97 ( 18 ) 79 93 ( 10 ) 83 Backlog 38 ( 37 ) 1 32 ( 29 ) 3 Trade names 1 ( 1 ) — 1 — 1 Total finite-lived intangible assets 2,088 ( 1,007 ) 1,081 1,946 ( 826 ) 1,120 Indefinite-lived intangible assets: In-process research and development 92 — 92 92 — 92 Trade names 4 — 4 4 — 4 Total indefinite-lived intangible assets 96 — 96 96 — 96 Total intangible assets $ 2,184 $ ( 1,007 ) $ 1,177 $ 2,042 $ ( 826 ) $ 1,216 Amortization expense related to intangible assets was $ 228 million, $ 198 million and $ 173 million for fiscal 2021, 2020 and 2019, respectively. The estimated annual amortization expense related to finite-lived intangible assets as of December 31, 2021, is as follows: Fiscal Year Ending (in millions) 2022 $ 234 2023 204 2024 151 2025 121 2026 97 2027 and thereafter 274 $ 1,081 Actual amortization expense in future periods could differ from these estimates as a result of future acquisitions, divestitures, impairments, the outcome and timing of completion of in-process research and development projects and other factors. In the fourth quarter of fiscal 2021, in connection with the annual goodwill assessment, we evaluated indefinite-lived intangibles for impairment and concluded that no impairment was necessary. Leidos Holdings, Inc. Annual Report - 81 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 9—Property, Plant and Equipment Property, plant and equipment, net consisted of the following: December 31, 2021 January 1, 2021 (in millions) Computers and other equipment $ 472 $ 386 Leasehold improvements 367 321 Buildings and improvements 140 142 Office furniture and fixtures 65 60 Land 18 18 Construction in progress 78 72 1,140 999 Less: accumulated depreciation and amortization ( 470 ) ( 395 ) $ 670 $ 604 Depreciation expense was $ 97 million, $ 84 million and $ 61 million for fiscal 2021, 2020 and 2019, respectively. Sale and Leaseback Agreements Gaithersburg, MD Property On December 31, 2018, we closed the sale and leaseback agreement relating to our land and building in Gaithersburg, MD. We received proceeds of $ 31 million, net of selling costs, for the property, which had a carrying value of $ 31 million. The proceeds received in fiscal 2019 were recorded as investing activities on the consolidated statements of cash flows. San Diego, CA Properties On December 28, 2018, we closed the sale and leaseback agreement relating to two buildings and the adjacent land in San Diego, CA for consideration of $ 79 million, net of selling costs. The carrying value of the land and buildings was $ 14 million. We received cash proceeds of $ 14 million upon closing, which were recorded as financing activities on the consolidated statements of cash flows, and recognized a short-term receivable for the remaining $ 65 million of consideration. Prior to the adoption of ASC 842, the consideration of $ 79 million was accounted for as a financing transaction and a note payable was recorded. Under ASC 842, the transaction qualified as a sale-leaseback and consequently the debt of $ 79 million and the carrying value of the property of $ 14 million, net of the related tax impact of $ 17 million, were reclassified into retained earnings as a cumulative effect adjustment. The proceeds of $ 65 million received in fiscal 2019 were recorded as investing activities on the consolidated statements of cash flows. Leidos Holdings, Inc. Annual Report - 82 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10—Leases Lessee ROU assets and lease liabilities consisted of the following: Balance sheet line item December 31, 2021 January 1, 2021 (in millions) ROU assets: Finance leases Property, plant and equipment, net $ 51 $ 10 Operating leases Operating lease right-of-use assets, net 612 581 $ 663 $ 591 Current lease liabilities: Finance leases Short-term debt and current portion of long-term debt $ 9 $ 6 Operating leases Accounts payable and accrued liabilities 140 127 $ 149 $ 133 Non-current lease liabilities: Finance leases Long-term debt, net of current portion $ 43 $ 5 Operating leases Operating lease liabilities 589 564 $ 632 $ 569 In March 2020, we took occupancy of our new corporate headquarters in Reston, VA. As a result, we recorded $ 104 million of ROU assets and $ 132 million of lease liabilities. During fiscal 2020, we made a decision to vacate one of our facilities. The carrying amount was determined to be less than the expected recovery from sublease income and as a result, we recorded an impairment charge of $ 11 million, which was recorded within our Health reportable segment. Total lease cost for the periods presented consisted of the following: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Finance lease cost: Amortization of ROU assets $ 11 $ 9 $ 8 Interest on lease liabilities 1 — 1 12 9 9 Operating lease cost (1) 172 169 155 Variable lease cost 90 103 107 Short-term lease cost 4 8 7 Less: Sublease income ( 8 ) ( 11 ) ( 6 ) Total lease cost $ 270 $ 278 $ 272 (1) Includes ROU lease expense of $ 150 million, $ 145 million and $ 136 million for fiscal 2021, 2020 and 2019, respectively. Lease costs and sublease income are included in "Cost of revenues" and "Selling, general and administrative expenses" within the consolidated statements of income. Leidos Holdings, Inc. Annual Report - 83 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Lease terms and discount rates related to leases were as follows: December 31, 2021 January 1, 2021 January 3, 2020 Weighted-average remaining lease term (in years): Finance leases 8.4 2.9 2.4 Operating leases 6.8 7.3 5.7 Weighted-average discount rate: Finance leases 2.5 % 2.7 % 4.2 % Operating leases 3.2 % 3.5 % 4.1 % Other information related to leases was as follows: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Cash paid for amounts included in measurement of lease liabilities: Operating cash related to finance leases $ 1 $ — $ 1 Operating cash related to operating leases 174 164 163 Financing cash flows related to finance leases 11 9 8 Lease liabilities arising from obtaining ROU assets: Finance lease liabilities $ 51 $ 12 $ — Operating lease liabilities 161 314 141 The change in operating ROU assets and lease liabilities are presented within cash flows from operations on the consolidated statements of cash flows. Future minimum lease commitments of our finance and operating leases on an undiscounted basis, reconciled to the respective lease liability at December 31, 2021, were as follows: Fiscal Year Ending Finance lease commitments Operating lease commitments (in millions) 2022 $ 10 $ 162 2023 7 144 2024 5 129 2025 5 90 2026 5 68 2027 and thereafter 26 224 Total undiscounted cash flows 58 817 Less: imputed interest ( 6 ) ( 88 ) Lease liability as of December 31, 2021 $ 52 $ 729 Lessor As of December 31, 2021 and January 1, 2021, we had a total net investment in sales-type leases, which relates to lease payment receivables, of $ 93 million and $ 64 million, respectively. The current and non-current portions of net investment in sales-type leases are included within "Other current assets" and "Other assets", respectively, on the consolidated balance sheets. Leidos Holdings, Inc. Annual Report - 84 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The components of lease income were as follows: Year Ended Income statement line item December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Sales-type leases: Selling price at lease commencement Revenues $ 80 $ 61 $ 84 Cost of underlying asset Cost of revenues ( 60 ) ( 47 ) ( 86 ) Operating income (loss) 20 14 ( 2 ) Interest income on lease receivables Revenues 8 8 6 28 22 4 Operating lease income Revenues 32 31 28 Total lease income $ 60 $ 53 $ 32 As of December 31, 2021, undiscounted cash flows for sales-type and operating leases for the next five years are as follows: Fiscal Year Ending Sales-type leases Operating leases (in millions) 2022 $ 44 $ 23 2023 29 26 2024 18 27 2025 11 — 2026 3 — Total undiscounted cash flows $ 105 $ 76 Present value of lease payments as lease receivables 93 Difference between undiscounted cash flows and discounted cash flows $ 12 Note 11—Fair Value Measurements Financial instruments measured on a recurring basis at fair value consisted of the following: December 31, 2021 January 1, 2021 Carrying value Fair value Carrying value Fair value (in millions) Financial liabilities: Derivatives $ 53 $ 53 $ 103 $ 103 As of December 31, 2021, our derivatives primarily consisted of the cash flow interest rate swaps on $ 1.0 billion of the variable rate senior unsecured term loan (see "Note 12—Derivative Instruments"). The fair value of the cash flow interest rate swaps is determined based on observed values for underlying interest rates on the LIBOR yield curve (Level 2 inputs). Financial instruments measured on a recurring basis at fair value also include our defined benefit plan assets (Level 2 inputs). See "Note 19—Retirement Plans" for further details on these investments. The carrying amounts of our financial instruments, other than derivatives, which include cash equivalents, accounts receivable, accounts payable and accrued expenses, are reasonable estimates of their related fair values. The carrying value of our notes receivable of $ 15 million as of December 31, 2021 and January 1, 2021 approximates fair value as the stated interest rates within the agreements are consistent with the current market rates used in notes with similar terms in the market (Level 2 inputs). Leidos Holdings, Inc. Annual Report - 85 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2021 and January 1, 2021, the fair value of debt was $ 5.4 billion and $ 5.2 billion, respectively, and the carrying amount was $ 5.1 billion and $ 4.7 billion, respectively (see "Note 13—Debt"). The fair value of debt is determined based on current interest rates available for debt with terms and maturities similar to our existing debt arrangements (Level 2 inputs). On May 7, 2021, January 14, 2021, May 4, 2020 and January 31, 2020, non-financial instruments measured at fair value on a non-recurring basis were recorded in connection with the acquisitions of Gibbs & Cox, 1901 Group, SD&A Businesses and Dynetics, respectively. The fair values of the assets acquired and liabilities assumed were determined using Level 3 inputs. See "Note 5—Acquisitions and Divestitures" for further details on these acquisitions. We also had real estate property measured at fair value, using Level 2 inputs, on July 3, 2020, which resulted in an impairment charge of $ 11 million (see "Note 10—Leases"). As of December 31, 2021 and January 1, 2021, we did not have any assets or liabilities measured at fair value on a non-recurring basis. Note 12—Derivative Instruments The fair value of the interest rate swaps was as follows: Liability derivatives Balance sheet line item December 31, 2021 January 1, 2021 (in millions) Cash flow interest rate swaps Other long-term liabilities $ 53 $ 103 The cash flows associated with the interest rate swaps are classified as operating activities in the consolidated statements of cash flows. Cash Flow Hedges We have interest rate swap agreements to hedge the cash flows of $ 1.0 billion of the variable rate senior unsecured term loan (the "Variable Rate Loan"). These interest rate swap agreements have a maturity date of August 2025 and a fixed interest rate of 3.00 %. The objective of these instruments is to reduce variability in the forecasted interest payments of the Variable Rate Loan, which are based on the LIBOR rate. Under the terms of the interest rate swap agreements, we will receive monthly variable interest payments based on the one-month LIBOR rate and will pay interest at a fixed rate. The interest rate swap transactions were accounted for as cash flow hedges. The gain (loss) on the swap is reported as a component of other comprehensive income (loss) and is reclassified into earnings when the interest payments on the underlying hedged items impact earnings. A qualitative assessment of hedge effectiveness is performed on a quarterly basis, unless facts and circumstances indicate the hedge may no longer be highly effective. The effect of the cash flow hedges on other comprehensive income (loss) and earnings for the periods presented was as follows: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Total interest expense, net presented in the consolidated statements of income in which the effects of cash flow hedges are recorded $ 184 $ 179 $ 133 Amount recognized in other comprehensive income (loss) 18 ( 61 ) ( 55 ) Amount reclassified from accumulated other comprehensive loss to interest expense, net 19 14 ( 7 ) We expect to reclassify losses of $ 26 million from accumulated other comprehensive loss into earnings during the next 12 months. Leidos Holdings, Inc. Annual Report - 86 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 13—Debt Debt consisted of the following: Stated interest rate Effective interest rate December 31, 2021 (1) January 1, 2021 (1) (in millions) Short-term debt: Senior unsecured term loans: $ 380 million term loan, due May 2022 1.24 % 1.34 % $ 380 $ — Long-term debt: Senior unsecured term loan: $ 1,925 million Term Loan, due January 2025 1.49 % 1.75 % $ 1,298 $ 1,391 Senior unsecured notes: $ 500 million notes, due May 2023 (2) 2.95 % 3.17 % 498 497 $ 500 million notes, due May 2025 (2) 3.63 % 3.76 % 497 496 $ 750 million notes, due May 2030 (2) 4.38 % 4.50 % 738 737 $ 1,000 million notes, due February 2031 (2) 2.30 % 2.38 % 990 989 $ 250 million notes, due July 2032 7.13 % 7.43 % 247 247 $ 300 million notes, due July 2033 5.50 % 5.88 % 158 158 $ 300 million notes, due December 2040 5.95 % 6.03 % 216 216 Notes payable and finance leases due on various dates through fiscal 2032 1.56 %- 4.18 % Various 54 13 Total long-term debt 4,696 4,744 Less: current portion ( 103 ) ( 100 ) Total long-term debt, net of current portion $ 4,593 $ 4,644 (1) The carrying amounts of the senior term loans and notes as of December 31, 2021 and January 1, 2021, include the remaining principal outstanding of $ 5,065 million and $ 4,782 million, respectively, less total unamortized debt discounts and deferred debt issuance costs of $ 43 million and $ 51 million, respectively. (2) We filed a Registration Statement on Form S-4 with the Securities and Exchange Commission on May 6, 2021, which was declared effective on May 19, 2021. Term Loans and Revolving Credit Facility On May 7, 2021, we entered into a Credit Agreement (the "2021 Credit Agreement") with certain financial institutions, which provided for a senior unsecured term loan facility in an aggregate principal amount of $ 380 million with maturity 364 days after the 2021 Credit Agreement date. The proceeds were used to fund the acquisition of Gibbs & Cox. Borrowings under the 2021 Credit Agreement bear interest at a rate determined, at our option, based on either an alternate base rate plus 0.13 % or a LIBOR rate plus 1.13 %. The financial covenants in the 2021 Credit Agreement require that we maintain, as of the last day of each fiscal quarter, a ratio of adjusted consolidated total debt to consolidated EBITDA of not more than 3.75 to 1.00, subject to increases to 4.50 to 1.00 following a material acquisition, and a ratio of EBITDA to consolidated interest expense of not less than 3.50 to 1.00. On January 17, 2020 (the "Closing Date"), we entered into a Credit Agreement (the "Credit Agreement") with certain financial institutions, which provided for a senior unsecured term loan facility in an aggregate principal amount of $ 1.9 billion (the "Term Loan Facility") and a $ 750 million senior unsecured revolving facility (the "Revolving Facility" and, together with the Term Loan Facility, the "Credit Facilities"). The Credit Facilities will mature five years from the Closing Date, with the Revolving Facility subject to two additional one year extensions. Leidos Holdings, Inc. Annual Report - 87 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The proceeds of the Term Loan Facility and cash on hand on the Closing Date were used 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 (the "Terminated Credit Agreements"). As a result of the termination of the liens under the Terminated Credit Agreements, the liens securing the $ 450 million notes due 2020 and $ 300 million notes due 2040 were also released and such notes became senior unsecured obligations. Borrowings under the Credit Agreement bear interest at a rate determined, at our option, based on either an alternate base rate or a LIBOR rate plus, in each case, an applicable margin that varies depending on our credit rating. The applicable margin range for LIBOR-denominated borrowings is from 1.13 % to 1.75 %. Based on our current ratings, the applicable margin for LIBOR-denominated borrowings is 1.38 %. The financial covenants in the Credit Agreement require that we maintain, as of the last day of each fiscal quarter, a ratio of adjusted consolidated total debt to consolidated EBITDA of not more than 3.75 to 1.00, subject to two increases to 4.50 to 1.00 following a material acquisition, and a ratio of EBITDA to consolidated interest expense of not less than 3.50 to 1.00. Senior 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 2031 Notes are senior unsecured obligations issued by Leidos, Inc. and guaranteed by Leidos Holdings, Inc. The annual interest rate for the 2031 Notes is 2.30 %. 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. Additionally, on May 12, 2020, we issued and sold $ 500 million senior notes maturing in May 2023 (the "2023 Notes"), $ 500 million senior notes maturing in May 2025 (the "2025 Notes") and $ 750 million senior notes maturing in May 2030 (the "2030 Notes", and together with the 2023 Notes and 2025 Notes, the "Notes"). The annual interest rate for the 2023 Notes, 2025 Notes and 2030 Notes is 2.95 %, 3.63 % and 4.38 %, respectively. The proceeds from the Notes were used to repay all of the outstanding obligations in respect of principal, interest and fees under the January 31, 2020 Bridge Credit Agreement and to repay a portion of the outstanding loans under the February 12, 2020 Facility. Commercial Paper On July 12, 2021, we established a commercial paper program in which the Company may issue short-term unsecured commercial paper notes ("Commercial Paper Notes") not to exceed $ 750 million. The proceeds will be used for general corporate purposes, including working capital, capital expenditures, acquisitions and share repurchases. The Commercial Paper Notes will be issued in minimum denominations of $ 0.25 million and will have maturities of up to 397 days from the date of issuance. The Commercial Paper Notes will bear either a stated or floating interest rate, if interest bearing, or will be sold at a discount from the face amount. As of December 31, 2021, we did not have any Commercial Paper Notes outstanding. Principal Payments and Debt Issuance Costs 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. During fiscal 2021 and 2020, there were no borrowings under the credit facilities. Principal payments are made quarterly on our variable rate senior unsecured term loan, with the majority of the principal due at maturity. Interest on the variable rate senior unsecured term loan is payable on a periodic basis, which must be at least quarterly. Interest on the senior fixed rate unsecured notes is payable on a semi-annual basis with principal payments due at maturity. Leidos Holdings, Inc. Annual Report - 88 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In connection with the financing activity from prior year, $ 68 million of debt discount and debt issuance costs related to the debt and revolving credit facility were recognized, which were recorded as an offset against the carrying value of debt and capitalized within "Other assets" in the consolidated balance sheets, respectively. For fiscal 2020, $ 36 million of debt discount and debt issuance costs were written off related to the Terminated Credit Agreements and loan facility repayments. Amortization of debt discount and debt issuance costs was $ 11 million, $ 16 million and $ 10 million for fiscal 2021, 2020 and 2019, respectively. Our borrowings under the Credit Facilities, 2021 Credit Agreement, the Notes and the Commercial Paper Notes are fully and unconditionally guaranteed by intercompany guarantees. In addition, the agreements governing debt outstanding under the Credit Facilities, 2021 Credit Agreement, and the Notes contain certain customary restrictive covenants, including among other things, restrictions on our ability to create liens and enter into sale and leaseback transactions under certain circumstances. We were in compliance with all covenants as of December 31, 2021. Future minimum payments of debt are as follows: Fiscal Year Ending (in millions) 2022 $ 486 2023 675 2024 197 2025 1,353 2026 4 2027 and thereafter 2,404 Total principal payments 5,119 Less: unamortized debt discount and issuance costs ( 43 ) Total short-term and long-term debt $ 5,076 Leidos Holdings, Inc. Annual Report - 89 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 14—Accumulated Other Comprehensive Loss Changes in the components of accumulated other comprehensive loss were as follows: Foreign currency translation adjustments Unrecognized loss on derivative instruments Pension adjustments Total accumulated other comprehensive loss (in millions) Balance at December 28, 2018 $ ( 41 ) $ 14 $ ( 3 ) $ ( 30 ) Other comprehensive income (loss) 5 ( 55 ) ( 1 ) ( 51 ) Taxes 3 15 — 18 Reclassification from accumulated other comprehensive loss — ( 7 ) — ( 7 ) Balance at January 3, 2020 ( 33 ) ( 33 ) ( 4 ) ( 70 ) Other comprehensive income (loss) 70 ( 61 ) ( 3 ) 6 Taxes ( 7 ) 10 1 4 Reclassification from accumulated other comprehensive loss — 14 — 14 Balance at January 1, 2021 30 ( 70 ) ( 6 ) ( 46 ) Other comprehensive income (loss) ( 3 ) 18 17 32 Taxes ( 5 ) ( 8 ) ( 4 ) ( 17 ) Reclassification from accumulated other comprehensive loss — 19 — 19 Balance at December 31, 2021 $ 22 $ ( 41 ) $ 7 $ ( 12 ) Reclassifications for unrecognized gain (loss) on derivative instruments are associated with outstanding debt and are recorded in "Interest expense, net" on the consolidated statements of income. See "Note 12—Derivative Instruments" for more information on our interest rate swap agreements. Leidos Holdings, Inc. Annual Report - 90 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 15—Composition of Certain Financial Statement Captions Balance Sheet December 31, 2021 January 1, 2021 (in millions) Other current assets: Restricted cash $ 148 $ 163 Transition costs and project assets (1) 110 104 Pre-contract costs 5 7 Other (2) 166 128 $ 429 $ 402 Other assets: Transition costs and project assets (1) $ 121 $ 187 Equity method investments (3) 25 15 Other (2) 293 256 $ 439 $ 458 Accounts payable and accrued liabilities: Accrued liabilities $ 1,053 $ 939 Accounts payable 692 731 Deferred revenue 364 481 Other (2) 32 24 $ 2,141 $ 2,175 Accrued payroll and employee benefits: Accrued vacation $ 351 $ 329 Salaries, bonuses and amounts withheld from employees’ compensation 254 303 $ 605 $ 632 (1) During the year ended December 31, 2021 and January 1, 2021, $ 428 million and $ 575 million, respectively, of amortization was recognized related to transition costs and project assets. (2) Balance represents items that are not individually significant to disclose separately. (3) Balances are net of $ 16 million and $ 23 million of dividends received during fiscal 2021 and fiscal 2020, respectively, that were recorded in cash flows provided by operating activities of continuing operations on the consolidated statements of cash flows. Year Ended Income Statement December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Interest expense, net: Interest expense $ ( 185 ) $ ( 182 ) $ ( 147 ) Interest income 1 3 14 $ ( 184 ) $ ( 179 ) $ ( 133 ) Other (expense) income, net: Loss on debt extinguishment $ — $ ( 36 ) $ — (Loss) gain on sale of businesses ( 3 ) — 88 Loss on foreign currencies ( 1 ) ( 4 ) ( 1 ) Other income, net 3 2 — $ ( 1 ) $ ( 38 ) $ 87 Leidos Holdings, Inc. Annual Report - 91 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 16—Earnings Per Share ("EPS") Basic EPS is computed by dividing net income attributable to Leidos common stockholders by the basic weighted average number of shares outstanding. Diluted EPS is calculated to give effect to all potentially dilutive common shares that were outstanding during the reporting period. The dilutive effect of outstanding equity-based compensation awards is reflected in diluted EPS by application of the treasury stock method, only in periods in which such effect would have been dilutive for the period. We issue unvested stock awards that have forfeitable rights to dividends or dividend equivalents. These stock awards are dilutive common share equivalents subject to the treasury stock method. The weighted average number of shares used to compute basic and diluted EPS attributable to Leidos stockholders were: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Basic weighted average number of shares outstanding 141 142 143 Dilutive common share equivalents—stock options and other stock awards 2 2 2 Diluted weighted average number of shares outstanding 143 144 145 Anti-dilutive stock-based awards are excluded from the weighted average number of shares outstanding used to compute diluted EPS. For fiscal 2021, there was 1 million of outstanding stock options and vesting stock awards that were anti-dilutive. For fiscal 2020 and 2019, there were no significant anti-diluted equity awards. Share Repurchases 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. All shares repurchased were immediately retired. In fiscal 2019, we entered into accelerated share repurchase agreements with two financial institutions to repurchase shares of our outstanding common stock. We paid $ 400 million to the financial institutions and received 5.6 million shares. The purchase was recorded to "Additional paid-in capital" in the consolidated balance sheets. All shares delivered were immediately retired. Note 17—Stock-Based Compensation Plan Summaries As of December 31, 2021, we had stock-based compensation awards outstanding under the following plans: the 2017 Omnibus Incentive Plan, the 2006 Equity Incentive Plan, as amended, and the 2006 Employee Stock Purchase Plan, as amended ("ESPP"). We issue new shares upon the vesting of stock units or exercising of stock options under these plans. The 2017 Omnibus Incentive Plan provides Leidos and its affiliates' employees, directors and consultants the opportunity to receive various types of stock-based compensation awards, such as stock options, restricted stock units and performance-based awards, as well as cash awards. We grant service-based awards that generally vest or become exercisable 25 % a year over four years or cliff vest in three years . As of December 31, 2021, 3.9 million shares of Leidos' stock were reserved for future issuance under the 2017 Omnibus Incentive Plan and the 2006 Equity Incentive Plan. We offer eligible employees the opportunity to defer restricted stock units into an equity-based deferred equity compensation plan, the Key Executive Stock Deferral Plan ("KESDP"). Prior to 2013, we offered an additional opportunity for deferrals into the Management Stock Compensation Plan ("MSCP"). Benefits from these plans are payable in shares of Leidos' stock that are held in a trust for the purpose of funding shares to the plans' participants. Restricted stock units deferred under the KESDP are counted against the total shares available for future issuance under the 2017 Omnibus Incentive Plan. All awards under the MSCP are fully vested and the plan does not provide for a maximum number of shares available for future issuance. Leidos Holdings, Inc. Annual Report - 92 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Our ESPP allows eligible employees to purchase shares of Leidos' stock at a discount of up to 15 % of the fair market value on the date of purchase. During fiscal 2021, 2020 and 2019, the discount was 10 % of the fair market value on the date of purchase. During fiscal 2021, 2020 and 2019, $ 39 million, $ 32 million and $ 25 million, respectively, was received from ESPP plan participants for the issuance of Leidos' stock. A total of 3.4 million shares remain available for future issuance under the ESPP. Stock-based compensation and related tax benefits recognized under all plans were as follows: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Total stock-based compensation expense $ 67 $ 62 $ 52 Tax benefits recognized from stock-based compensation 17 15 13 Stock Options Stock options are granted with exercise prices equal to the fair market value of Leidos' common stock on the date of grant and for terms not greater than ten years . Stock options have a term of seven years and a vesting period of four years , except for stock options granted to our outside directors, which have a vesting period of the earlier of one year from grant date or the next annual meeting of stockholders following grant date. The fair value of the stock option awards is estimated on the date of grant using the Black-Scholes-Merton option-pricing model. The fair value of the stock option awards to employees are expensed on a straight-line basis over the vesting period of four years , except for stock options granted to our outside directors, which is recognized over the vesting period of one year or less. During fiscal 2021, 2020 and 2019, we used a blended approach to measure expected volatility that is based on our weighted average historical and implied volatilities. The risk-free rate is derived using the yield curve of a zero-coupon U.S. Treasury bond with a maturity equal to the expected term of the stock option on the grant date. To determine the expected term, we use the midpoint scenario with a one-year grant date filter assumption for outstanding options and we use historical data to estimate forfeitures. The weighted average grant-date fair value and assumptions used to determine fair value of stock options granted for the periods presented were as follows: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 Weighted average grant-date fair value $ 20.23 $ 19.64 $ 11.89 Expected term (in years) 4.6 4.5 4.4 Expected volatility 29.6 % 25.0 % 24.3 % Risk-free interest rate 0.7 % 0.6 % 2.4 % Dividend yield 1.3 % 1.3 % 2.2 % Leidos Holdings, Inc. Annual Report - 93 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Stock option activity for each of the periods presented was as follows: Shares of stock under stock options Weighted average exercise price Weighted average remaining contractual term Aggregate intrinsic value (in millions) (in years) (in millions) Outstanding at December 28, 2018 2.4 $ 39.41 3.8 $ 36 Options granted 0.5 63.61 Options forfeited or expired — 58.08 Options exercised ( 0.5 ) 30.86 21 Outstanding at January 3, 2020 2.4 $ 46.04 3.8 $ 128 Options granted 0.3 106.73 Options forfeited or expired ( 0.1 ) 66.84 Options exercised ( 0.4 ) 35.94 29 Outstanding at January 1, 2021 2.2 $ 56.01 3.5 $ 108 Options granted 0.3 90.25 Options forfeited or expired — 85.42 Options exercised ( 0.4 ) 38.79 27 Outstanding at December 31, 2021 2.1 $ 65.18 3.5 $ 54 Exercisable at December 31, 2021 1.2 $ 51.47 2.3 $ 48 Vested and expected to vest in the future as of December 31, 2021 2.0 $ 64.91 3.4 $ 54 As of December 31, 2021, there was $ 5 million of unrecognized compensation cost, net of estimated forfeitures, related to stock options, which is expected to be recognized over a weighted-average period of 2.1 years. Tax benefits from stock options exercised for fiscal 2021, 2020 and 2019 were $ 6 million, $ 7 million and $ 5 million, respectively. Restricted Stock Units and Awards Compensation expense is measured at the grant date fair value and generally recognized over the vesting period of either three to four years based upon required service conditions and in some cases revenue or EPS-based performance conditions. Leidos Holdings, Inc. Annual Report - 94 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Restricted stock units and awards activity for each of the periods presented was as follows: Shares of stock under stock awards Weighted average grant- date fair value (in millions) Unvested stock awards at December 28, 2018 2.0 $ 50.85 Awards granted 0.6 64.70 Awards forfeited ( 0.1 ) 60.20 Awards vested ( 1.1 ) 44.10 Unvested stock awards at January 3, 2020 1.4 $ 60.91 Awards granted 0.5 106.38 Awards forfeited ( 0.1 ) 79.61 Awards vested ( 0.5 ) 56.36 Unvested stock awards at January 1, 2021 1.3 $ 79.05 Awards granted 0.7 91.09 Awards forfeited ( 0.1 ) 89.56 Awards vested ( 0.5 ) 71.60 Unvested stock awards at December 31, 2021 1.4 $ 88.89 As of December 31, 2021, there was $ 50 million of unrecognized compensation cost, net of estimated forfeitures, related to restricted stock units, which is expected to be recognized over a weighted average period of 2.0 years. The fair value of restricted stock units that vested in fiscal 2021, 2020 and 2019 was $ 48 million, $ 58 million and $ 66 million, respectively. In addition, the fair value of dividend equivalents with respect to restricted stock units that vested in fiscal 2021, 2020 and 2019 was immaterial. Performance-Based Stock Awards Performance-based stock awards vest and the stock is issued at the end of a three-year period based upon the achievement of specific performance criteria, with the number of shares ultimately awarded, if any, ranging up to 150 % of the specified target awards. If performance is below the threshold level of performance, no shares will be issued. For awards granted during fiscal 2021, 2020 and 2019, the target number of shares of stock granted under the awards will vest and the stock will be issued at the end of a three-year period based on a three-year cycle performance period and the actual number of shares to be issued will be based upon the achievement of the three-year cycle's performance criteria. Also, during fiscal 2021, 2020 and 2019, we granted performance-based awards with market conditions. These market conditions grants represent the target number of shares and the actual number of shares to be awarded upon vesting may be higher or lower depending upon the achievement of the relevant market conditions. The target number of shares granted under the market conditions grants will vest and the stock will be issued at the end of a three-year period based on the attainment of certain total shareholder return performance measures and the employee's continued service through the vest date. Leidos Holdings, Inc. Annual Report - 95 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Performance-based stock award activity for each of the periods presented was as follows: Expected number of shares of stock to be issued under performance-based stock awards Weighted average grant- date fair value (in millions) Unvested at December 28, 2018 0.5 $ 57.36 Awards granted 0.2 66.92 Awards forfeited — 66.72 Awards vested ( 0.1 ) 45.83 Unvested at January 3, 2020 0.6 $ 63.66 Awards granted 0.2 103.34 Awards forfeited ( 0.1 ) 72.96 Awards vested ( 0.2 ) 58.61 Unvested at January 1, 2021 0.5 $ 80.20 Awards granted 0.2 86.88 Awards forfeited — 89.65 Awards vested ( 0.2 ) 65.30 Unvested at December 31, 2021 0.5 $ 88.72 The weighted average grant date fair value for performance-based stock, excluding those with a market condition, during fiscal 2021, 2020 and 2019 was $ 89.26 , $ 106.80 and $ 62.66 , respectively. The weighted average grant date fair value for performance-based stock with market conditions that were granted during fiscal 2021, 2020 and 2019 was $ 88.21 , $ 127.92 and $ 72.53 , respectively, and was calculated using the Monte Carlo simulation. The Monte Carlo simulation assumptions used for the periods presented were as follows: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 Expected volatility 32.86 % 23.99 % 22.02 % Risk free rate of return 0.29 % 0.50 % 2.39 % Weighted average grant date stock price $ 90.85 $ 105.12 $ 62.66 As of December 31, 2021, there was $ 18 million of unrecognized compensation cost, net of estimated forfeitures, which is expected to be recognized over a weighted average period of 1.6 years. The fair value of performance-based stock awards that vested in fiscal 2021, 2020 and 2019 was $ 19 million, $ 25 million, and $ 9 million, respectively. Leidos Holdings, Inc. Annual Report - 96 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 18—Income Taxes The provision for income taxes for the periods presented included the following: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Current: Federal $ 156 $ 90 $ 122 State 49 37 31 Foreign 29 28 25 Deferred: Federal ( 20 ) 13 26 State ( 3 ) ( 11 ) ( 3 ) Foreign ( 3 ) ( 5 ) ( 5 ) Total $ 208 $ 152 $ 196 A reconciliation of the provision for income taxes to the amount computed by applying the statutory federal income tax rate to income before income taxes for the periods presented was as follows: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Amount computed at the statutory federal income tax rate $ 203 $ 164 $ 182 State income taxes, net of federal tax benefit 34 20 22 Research and development credits ( 23 ) ( 26 ) ( 11 ) Excess tax benefits from stock-based compensation ( 11 ) ( 15 ) ( 11 ) Change in valuation allowance for deferred tax assets 5 ( 5 ) 6 Impact of foreign operations 4 11 2 Dividends paid to employee stock ownership plan ( 2 ) ( 2 ) ( 2 ) Change in accruals for uncertain tax positions 1 1 4 Stock basis in subsidiary held for sale — — 5 Other ( 3 ) 4 ( 1 ) Total $ 208 $ 152 $ 196 Effective income tax rate 21.5 % 19.5 % 22.6 % 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. Leidos Holdings, Inc. Annual Report - 97 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Deferred income taxes are recorded for differences in the basis of assets and liabilities for financial reporting purposes and tax reporting purposes. Deferred tax assets (liabilities) were comprised of the following: December 31, 2021 January 1, 2021 (in millions) Operating lease liabilities $ 187 $ 176 Accrued vacation and bonuses 91 87 Reserves 47 62 Deferred compensation 39 31 Credits and net operating losses carryovers 26 22 Vesting stock awards 24 22 Deferred revenue 16 — Accumulated other comprehensive loss — 16 Investments — 1 Other 9 7 Total deferred tax assets 439 424 Valuation allowance ( 21 ) ( 16 ) Deferred tax assets, net of valuation allowance $ 418 $ 408 Purchased intangible assets $ ( 413 ) $ ( 409 ) Operating lease right-of-use assets ( 158 ) ( 148 ) Property, plant and equipment ( 63 ) ( 63 ) Accumulated other comprehensive income ( 1 ) — Employee benefit contributions — ( 7 ) Deferred revenue — ( 1 ) Other ( 9 ) ( 5 ) Total deferred tax liabilities ( 644 ) ( 633 ) Net deferred tax liabilities $ ( 226 ) $ ( 225 ) At December 31, 2021, we had state net operating losses of $ 90 million and state tax credits of $ 3 million. Both will begin to expire in fiscal 2022; however, we expect to utilize $ 72 million and $ 3 million of these state net operating losses and state tax credits, respectively. We also had foreign net operating losses of $ 39 million, which do not expire. We expect to utilize $ 4 million of these foreign net operating losses. Our valuation allowance for deferred tax assets was $ 21 million and $ 16 million as of December 31, 2021 and January 1, 2021, respectively. The valuation allowance increased by $ 5 million primarily due to an increase related to foreign tax credits partially offset by a decrease related to state attributes expected to be utilized. Leidos Holdings, Inc. Annual Report - 98 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Income tax balance sheet items are included in the accompanying consolidated balance sheets as follows: December 31, 2021 January 1, 2021 (in millions) Other current assets: Prepaid income taxes and tax refunds receivable $ 6 $ 12 Other assets: Deferred tax assets $ 13 $ 9 Accounts payable and accrued liabilities: Income taxes payable $ 29 $ 21 Deferred tax liabilities $ 239 $ 234 Other long-term liabilities: Unrecognized tax benefits $ 2 $ 4 Unrecognized tax benefits are primarily related to certain recurring deductions customary for our industry. The changes in the unrecognized tax benefits were as follows: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Unrecognized tax benefits at beginning of year $ 6 $ 5 $ 6 Additions for tax positions related to prior years 2 1 11 Reductions for tax positions related to prior years ( 2 ) — ( 1 ) Settlements with taxing authorities ( 3 ) — ( 11 ) Lapse of statute of limitations ( 1 ) — — Unrecognized tax benefits at end of year $ 2 $ 6 $ 5 Unrecognized tax benefits that, if recognized, would affect the effective income tax rate $ 2 $ 5 $ 4 At December 31, 2021, the balance of unrecognized tax benefits included liabilities for uncertain tax positions of $ 2 million, which were classified as other long-term liabilities on the consolidated balance sheets. At January 1, 2021, the balance of unrecognized tax benefits included liabilities for uncertain tax positions of $ 6 million, $ 4 million of which were classified as other long-term liabilities on the consolidated balance sheets. At January 3, 2020, the balance of unrecognized tax benefits included liabilities for uncertain tax positions of $ 5 million, $ 1 million of which were classified as other long-term liabilities on the consolidated balance sheets. We file income tax returns in the United States and various state and foreign jurisdictions. We participate in the Internal Revenue Service (“IRS”) Compliance Assurance Process ("CAP"), a real-time audit of our consolidated federal corporate income tax return. The IRS has examined our consolidated federal income tax returns through the year ended January 3, 2020. For the years ended January 1, 2021 and December 31, 2021, we were selected to participate in the phase of CAP reserved for taxpayers whose risk of noncompliance does not warrant use of IRS resources. We believe that participation in CAP should reduce tax-related uncertainties, if any. Additionally, with a few exceptions, as of December 31, 2021, we are no longer subject to state, local, or foreign examinations by the tax authorities for fiscal years ending on or before December 29, 2017. During the next 12 months, it is reasonably possible that resolution of reviews by taxing authorities, both domestic and international, could be reached with respect to $ 2 million of our unrecognized tax benefits, depending on the timing of ongoing examinations, any litigation and expiration of statute of limitations, either because the tax positions are sustained or because we agree to their disallowance and pay the related income tax. While we believe we have adequate accruals for uncertain tax positions, the tax authorities may determine that we owe taxes in excess of recorded accruals or the recorded accruals may be in excess of the final settlement amounts agreed to by tax authorities. Leidos Holdings, Inc. Annual Report - 99 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 19—Retirement Plans Defined Contribution Plans We sponsor various defined contribution plans in which most employees are eligible to participate. These plans allow eligible participants to contribute a portion of their income through payroll deductions and Leidos may also make discretionary contributions. Company contributions were $ 131 million, $ 120 million and $ 105 million for fiscal 2021, 2020 and 2019, respectively. Deferred Compensation Plans We maintain three deferred compensation plans, the Keystaff Deferral Plan ("KDP"), the KESDP and the MSCP (the "Plans"), for the benefit of certain management or highly compensated employees or members of the Board of Directors. The Plans allow eligible participants to elect to defer a portion of their salary, and all or a portion of certain bonuses, including restricted stock unit awards. Directors may also elect to defer their cash compensation in addition to their restricted stock unit awards. Deferred balances in the Plans are paid in lump sum or installments upon retirement, termination or the elected specified date. We do not make any contributions to the KDP but maintain participant accounts for deferred amounts and investments. We maintain a rabbi trust for the purpose of funding benefit payments to the KDP participants. Participants may allocate deferred salary and cash bonus amounts into a variety of designated investment options, with gains and losses based on the elected investment option performance with the participant assuming all risks related to future returns of their contributions. Under the KESDP, eligible participants may elect to defer in share units all or a portion of certain cash bonuses and restricted stock unit awards granted under the previous 2006 Equity Incentive Plan and the current 2017 Omnibus Incentive Plan (see "Note 17—Stock-Based Compensation"). Under the MSCP, restricted stock share units are fully vested and no further deferrals into the plan are made. We do not make any contributions to the accounts of KESDP or MSCP participants. Benefits from the KESDP and MSCP are payable in shares of Leidos common stock held in a rabbi trust for the purpose of funding benefit payments to KESDP and MSCP participants. Defined Benefit Plans We sponsor two frozen defined benefit pension plans ("the Plans"), one in the United Kingdom ("UK") for former employees on an expired customer contract and another assumed as a result of the Gibbs & Cox acquisition. We have continuing defined benefit pension obligations with respect to certain plan participants relating to the UK defined benefit pension plan. In fiscal 2012, we sold certain components of our business, including the component that contained the UK pension and employed the pension plan participants. Pursuant to the definitive sale agreement, we retained the assets and obligations of this defined benefit pension plan. As a result of retaining the pension obligation, the remaining immaterial components of ongoing pension expense, primarily interest costs and assumed return on plan assets subsequent to the sale, are recorded in continuing operations. The projected benefit obligation of the Plans as of December 31, 2021 and January 1, 2021, was $ 160 million and $ 138 million, respectively. The increase in the projected benefit obligation was primarily due to the defined benefit pension plan assumed through the acquisition of Gibbs & Cox. The fair value of the Plans assets as of December 31, 2021 and January 1, 2021, was $ 189 million and $ 157 million, respectively. The UK defined benefit pension plan funding status was overfunded $ 37 million and $ 19 million as of December 31, 2021 and January 1, 2021, respectively, and included within "Other assets" on the consolidated balance sheets. The Gibbs & Cox defined benefit pension plan funding status was underfunded $ 8 million as of December 31, 2021, and included within "Other long-term liabilities" on the consolidated balance sheets. Leidos Holdings, Inc. Annual Report - 100 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Other We also sponsor multiemployer defined benefit pension plans and a defined contribution plan (a 401(k) plan) (the "Sponsored Plans") for employees working on two U.S. government contracts. As part of the contractual agreements, the customers reimburse Leidos for contributions made to these Sponsored Plans as these costs are allowable under government contract cost accounting requirements. If we were to cease being the contractor as a result of a recompetition process, the defined benefit pension plans and related plan assets and liabilities would transfer to the new contractor. If the contract expires or is terminated with no transfer of the pension plan to a successor contractor, any amount by which the plan liabilities exceed plan assets, as of that date, will be reimbursed by the U.S. government customer. Since we are not responsible for the current or future funded status of the pension plans, no assets or liabilities arising from their funded status are recorded in the consolidated financial statements and no amounts associated with these pension plans are included in the defined benefit plan disclosures above. Note 20—Business Segments Our operations and reportable segments are organized around the customers and markets we serve. We define our reportable segments based on the way the chief operating decision maker ("CODM"), currently the Chairman and Chief Executive Officer, manages the operations for purposes of allocating resources and assessing performance. Our business is aligned into 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. Effective the beginning of fiscal 2020, certain contracts were reassigned from the Civil reportable segment to the Defense Solutions reportable segment to better align operations within the reportable segments to the customers they serve. Fiscal 2019 segment results have been recast to reflect this change. Defense Solutions provides leading-edge and technologically advanced services, solutions and products to a broad customer base. Our ever-changing technologies and innovations cover a wide spectrum of markets with primary areas of concentration in digital modernization and integrated systems, Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance technologies and services, transformative software, analytics, intelligence analysis, mission support and logistics services, weapons systems and human space exploration. We are dedicated to delivering cost-effective solutions backed by innovation-generating research and development to meet the evolving missions of our customers. We provide a diverse portfolio of national security solutions and systems for air, land, sea, space and cyberspace for the U.S. Intelligence Community, the DoD, the National Aeronautics and Space Administration, military services, government agencies of U.S. allies abroad and other federal and commercial customers in the national security industry. Our solutions deliver innovative technology, large-scale systems, command and control platforms, data analytics, logistics and cybersecurity solutions, as well as intelligence analysis and operations support to critical missions around the world. Our Civil business is focused on modernizing infrastructure, systems and security for government and commercial customers both domestically and internationally. By applying leading science, innovative technologies and business acumen, our talented employees help customers achieve their missions and take on the connected world with data-driven insights, improved efficiencies and technological advantages in the areas of transportation solutions, security detection and automation, digital transformation services and environment, energy and infrastructure. Our Health business focuses on delivering effective and affordable solutions to federal and commercial customers that are responsible for the health and well-being of people worldwide, including service members and veterans. Our solutions enable customers to deliver on the health mission of providing high-quality, cost-effective care, and are accomplished through the integration of information technology, engineering, life sciences, health services, clinical insights and health policy. The capabilities we provide predominantly fall in four major areas of activity: health information management services, managed health services, digital transformation and life sciences research and development. Leidos Holdings, Inc. Annual Report - 101 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Corporate includes the operations of various corporate activities, certain corporate expense items that are not reimbursed by our U.S. government customers and certain other expense items excluded from a reportable segment's performance. The following table summarizes business segment information for the periods presented: Year Ended December 31, 2021 January 1, 2021 January 3, 2020 (in millions) Revenues: Defense Solutions $ 8,032 $ 7,341 $ 6,300 Civil 3,157 2,994 2,796 Health 2,548 1,962 1,998 Total revenues $ 13,737 $ 12,297 $ 11,094 Operating income (loss): Defense Solutions $ 569 $ 506 $ 471 Civil 248 280 231 Health 442 235 242 Corporate ( 107 ) ( 23 ) ( 32 ) Total operating income $ 1,152 $ 998 $ 912 Amortization of intangible assets: Defense Solutions $ 121 $ 92 $ 64 Civil 73 66 63 Health 34 40 46 Total amortization of intangible assets $ 228 $ 198 $ 173 The income statement performance measures used to evaluate segment performance are revenues and operating income. As a result, "Interest expense, net," "Other (expense) income, net," and "Income tax expense," as reported in the consolidated financial statements are not allocated to our segments. Under U.S. government CAS, indirect costs including depreciation expense are collected in indirect cost pools, which are then collectively allocated out to the reportable segments based on a representative causal or beneficial relationship of the costs in the pool to the costs in the base. While depreciation expense is a component of the allocated costs, the allocation process precludes depreciation expense from being specifically identified by the individual reportable segments. For this reason, depreciation expense by reportable segment has not been reported above. Asset information by segment is not a key measure of performance used by the CODM. We generated approximately 87 % of our total revenues in fiscal 2021, 2020 and 2019 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, 49 % for fiscal 2020 and 48 % for fiscal 2019. Approximately 8 % of our revenues and tangible long-lived assets are generated by or owned by entities outside of the United States. As such, additional financial information by geographic location is not presented. Leidos Holdings, Inc. Annual Report - 102 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 21—Commitments and Contingencies Legal Proceedings Class Action Lawsuit On March 2, 2021, Leidos and certain current officers of Leidos were named as defendants in a putative class action securities lawsuit filed in the U.S. District Court for the Southern District of New York. The complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder relating to alleged misstatements or omissions in Leidos' public filings with the SEC and other public statements during the period from May 4, 2020 to February 23, 2021 relating, among other things, to Leidos' acquisition of the SD&A Businesses. The plaintiff sought to recover from the Company and the individual defendants an unspecified amount of damages at this time. On July 30, 2021, the District Court appointed a lead plaintiff and lead counsel. On September 28, 2021, the lead plaintiff voluntarily dismissed the action without prejudice. MSA Joint Venture On November 10, 2015, MSA received a final decision by the Department of Energy ("DoE") contracting officer for the Mission Support Contract concluding that certain payments to MSA by the DoE for the performance of IT services by Lockheed Martin Services, Inc. ("LMSI") under a subcontract to MSA constituted alleged affiliate fees in violation of Federal Acquisition Regulations ("FAR"). Lockheed Martin Integrated Technology LLC (now known as Leidos Integrated Technology LLC) is a member entity of MSA. Subsequent to the contracting officer's final decision, MSA, LMSI, and Lockheed Martin Corporation received notice from the U.S. Attorney's Office for the Eastern District of Washington that the U.S. government had initiated a False Claims Act investigation into the facts surrounding this dispute. On February 8, 2019, the Department of Justice filed a complaint in the United States District Court for the Eastern District of Washington against MSA, Lockheed Martin Corporation, Lockheed Martin Services, Inc. and a Lockheed Martin employee ("Defendants"). The complaint alleges violations of the False Claims Act, the Anti-Kickback Act and breach of contract with the DoE, among other things. On January 13, 2020, the Defendants' motions to dismiss were granted in part and denied in part. Litigation would proceed for the False Claims Act and other common law claims, although the Anti-Kickback Act claim has been dismissed with prejudice. The U.S. Attorney's office had previously advised that a parallel criminal investigation was open, although no subjects or targets of the investigation had been identified. The U.S. Attorney's office has informed MSA that it has closed the criminal investigation. Since this issue first was raised by the DoE, MSA has asserted that the IT services performed by LMSI under a fixed-price/fixed-unit rate subcontract approved by the DoE meet the definition of a "commercial item" under the FAR and any profits earned on that subcontract are permissible. MSA filed an appeal of the contracting officer's decision with the Civilian Board of Contract Appeals ("CBCA"), which was stayed pending resolution of the False Claims Act matter. Subsequent to the filing of MSA's appeal, the contracting officer demanded that MSA reimburse the DoE in the amount of $ 64 million, which was his estimate of the profits earned during the period from 2010 to 2014 by LMSI. The DoE has deferred collection of $ 32 million of that demand, pending resolution of the appeal and without prejudice to MSA's position that it is not liable for any of the DoE's $ 64 million reimbursement claim. On December 10, 2019, MSA received a second final decision by the DoE contracting officer, estimating approximately $ 29 million in alleged unallowable profit and associated general and administrative costs during the period from 2015 to 2016 by LMSI. MSA filed an appeal of the second contracting officer's decision, which has been consolidated with the prior proceeding before the CBCA and stayed pending resolution of the False Claims Act matter. The DoE and MSA also executed an agreement to defer the entire amount of the disallowed costs from the second contracting officer's final decision until the CBCA proceedings are finally resolved. Leidos has agreed to indemnify Jacobs Group, LLC and Centerra Group, LLC for any liability MSA incurs in this matter. Under the terms of the Separation Agreement, Lockheed Martin agreed to indemnify Leidos for 100 % of any damages in excess of $ 38 million up to $ 64 million, and 50 % of any damages in excess of $ 64 million, with respect to claims asserted against MSA related to this matter. On April 5, 2021, MSA finalized the settlement of the False Claims Act litigation in the Eastern District of Washington and the related contract claim at the CBCA. Pursuant to the settlement agreement, DoE paid MSA approximately $ 37 million on April 19, 2021 and MSA paid the Department of Justice $ 3 million on April 22, 2021. Accordingly, following joint motions by the parties, the CBCA dismissed the claim before the Board with prejudice on April 28, 2021 and the District Court dismissed the False Claims Act litigation with prejudice on April 30, 2021. Leidos Holdings, Inc. Annual Report - 103 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS There remain other outstanding matters in dispute between DoE and MSA as the two parties work to close out the Mission Support Contract. As of December 31, 2021, we believe we have adequately reserved for any potential liabilities related to these disputes. Other We are also involved in various claims and lawsuits arising in the normal conduct of our business, none of which, in the opinion of management, based upon current information, will likely have a material adverse effect on our financial position, results of operations or cash flows. Other Contingencies VirnetX, Inc. ("VirnetX") On April 10, 2018, a jury trial concluded in an additional patent infringement case brought by VirnetX against Apple, referred to as the Apple II case, in which the jury returned a verdict against Apple for infringement and awarded VirnetX damages in the amount of over $ 502 million. On April 11, 2018, in a second phase of the Apple II trial, the jury found Apple's infringement to be willful. On August 30, 2018, the federal trial court in the Eastern District of Texas entered a final judgment and rulings on post-trial motions in the Apple II case. The court affirmed the jury’s verdict of over $ 502 million and granted VirnetX’s motions for supplemental damages, a sunset royalty and royalty rate of $ 1.20 per infringing device, along with pre-judgment and post-judgment interest and costs. The court denied VirnetX’s motions for enhanced damages, attorneys’ fees and an injunction. The court also denied Apple’s motions for judgment as a matter of law and for a new trial. An additional sum of over $ 93 million for costs and pre-judgment interest was subsequently agreed upon pursuant to a court order, bringing the total award to VirnetX in the Apple II case to over $ 595 million. Apple filed an appeal of the judgment in the Apple II case with the U.S. Court of Appeals for the Federal Circuit, and on November 22, 2019, the Federal Circuit affirmed in part, reversed in part and remanded the Apple II case back to the District Court. The Federal Circuit affirmed that Apple infringed two of the patents at issue in the case, and ruled that Apple is precluded from making certain patent invalidity arguments. However, the Federal Circuit reversed the judgment that Apple infringed two other patents at issue, vacated the prior damages awarded in the Apple II case, and remanded the Apple II case back to the District Court for further proceedings regarding damages. On April 23, 2020, the District Court ordered a new trial on damages in the Apple II case, which was delayed by the coronavirus pandemic and started on October 26, 2020. On October 30, 2020, the jury awarded VirnetX $ 503 million in damages and specified a royalty rate of $ 0.84 per infringing device. In January 2021, the District Court entered final judgment affirming the jury award and the parties separately agreed on additional costs and interest of over $ 75 million, subject to Apple's appeal. On February 4, 2021, Apple filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit in the Apple II case. Under our agreements with VirnetX, Leidos would receive 25 % of the proceeds obtained by VirnetX after reduction for attorneys' fees and costs. However, the verdict in the Apple II case remains subject to the ongoing and potential future proceedings and appeals. In addition, the patents at issue in these cases are subject to U.S. Patent and Trademark Office post-grant inter partes review and/or reexamination proceedings and related appeals, which may result in all or part of these patents being invalidated or the claims of the patents being limited. Thus, no assurances can be given when or if we will receive any proceeds in connection with these jury awards. In addition, if Leidos receives any proceeds, we are required to pay a royalty to the customer who paid for the development of the technology. Government Investigations and Reviews We are routinely subject to investigations and reviews relating to compliance with various laws and regulations with respect to our role as a contractor to federal, state and local government customers and in connection with performing services in countries outside of the United States. Adverse findings could have a material effect on our business, financial position, results of operations and cash flows due to our reliance on government contracts. As of December 31, 2021, indirect cost audits by the DCAA remain open for fiscal 2016 and subsequent fiscal years. Although we have recorded contract revenues based upon an estimate of costs that we believe will be approved upon final audit or review, we cannot predict the outcome of any ongoing or future audits or reviews and adjustments and, if future adjustments exceed estimates, our profitability may be adversely affected. As of December 31, 2021, we believe we have adequately reserved for potential adjustments from audits or reviews of contract costs. Leidos Holdings, Inc. Annual Report - 104 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Through its internal processes, the Company discovered, in late 2021, activities by its employees, third party representatives and subcontractors, raising concerns related to a portion of our business that conducts international operations. The Company is conducting an internal investigation, overseen by an independent committee of the Board of Directors, with the assistance of external legal counsel, to determine whether the identified conduct may have violated the Company’s Code of Conduct and potentially applicable laws, including the U.S. Foreign Corrupt Practices Act ("FCPA"). The Company has voluntarily self-reported this investigation to the Department of Justice and the Securities and Exchange Commission and is cooperating with both agencies. Because the investigation is ongoing, the Company cannot anticipate the timing, outcome or possible impact of the investigation, although violations of the FCPA and other applicable laws may result in criminal and civil sanctions, including monetary penalties, and reputational damage. Commitments We have outstanding letters of credit of $ 55 million as of December 31, 2021, principally related to performance guarantees on contracts. We also have outstanding surety bonds with a notional amount of $ 100 million as of December 31, 2021, principally related to performance and subcontractor payment bonds on contracts. The value of the surety bonds may vary due to changes in the underlying project status and/or contractual modifications. As of December 31, 2021, the future expirations of the outstanding letters of credit and surety bonds were as follows: Fiscal year ending (in millions) 2022 $ 51 2023 5 2024 82 2025 1 2026 2 2027 and thereafter 14 $ 155 Leidos Holdings, Inc. Annual Report - 105 Table of Contents PART II Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.