Leidos Holdings, Inc. 10-Q

Item 1. Financial Statements. LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) April 1, 2022 December 31, 2021 (in millions) Assets: Cash and cash equivalents $ 297 $ 727 Receivables, net 2,419 2,189 Inventory, net 279 274 Other current assets 492 429 Total current assets 3,487 3,619 Property, plant and equipment, net 674 670 Intangible assets, net 1,109 1,177 Goodwill 6,742 6,744 Operating lease right-of-use assets, net 600 612 Other assets 418 439 Total assets $ 13,030 $ 13,261 Liabilities: Accounts payable and accrued liabilities $ 2,214 $ 2,141 Accrued payroll and employee benefits 724 605 Short-term debt and current portion of long-term debt 556 483 Total current liabilities 3,494 3,229 Long-term debt, net of current portion 4,569 4,593 Operating lease liabilities 582 589 Deferred tax liabilities 182 239 Other long-term liabilities 195 267 Total liabilities 9,022 8,917 Commitments and contingencies (Note 11) Stockholders’ equity: Common stock, $ 0.0001 par value, 500 million shares authorized, 137 million and 140 million shares issued and outstanding at April 1, 2022, and December 31, 2021, respectively — — Additional paid-in capital 1,928 2,423 Retained earnings 2,007 1,880 Accumulated other comprehensive income (loss) 20 ( 12 ) Total Leidos stockholders’ equity 3,955 4,291 Non-controlling interest 53 53 Total stockholders' equity 4,008 4,344 Total liabilities and stockholders' equity $ 13,030 $ 13,261 See accompanying notes to condensed consolidated financial statements. 1 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended April 1, 2022 April 2, 2021 (in millions, except per share amounts) Revenues $ 3,494 $ 3,315 Cost of revenues 2,982 2,848 Selling, general and administrative expenses 236 159 Acquisition, integration and restructuring costs 3 5 Equity loss (earnings) of non-consolidated subsidiaries 2 ( 5 ) Operating income 271 308 Non-operating expense: Interest expense, net ( 48 ) ( 45 ) Other expense, net ( 1 ) ( 1 ) Income before income taxes 222 262 Income tax expense ( 45 ) ( 57 ) Net income $ 177 $ 205 Less: net income attributable to non-controlling interest 2 — Net income attributable to Leidos common stockholders $ 175 $ 205 Earnings per share: Basic $ 1.26 $ 1.44 Diluted 1.25 1.42 See accompanying notes to condensed consolidated financial statements. 2 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) Three Months Ended April 1, 2022 April 2, 2021 (in millions) Net income $ 177 $ 205 Foreign currency translation adjustments 2 ( 4 ) Unrecognized gain on derivative instruments 29 13 Pension adjustments 1 — Total other comprehensive income, net of taxes 32 9 Comprehensive income 209 214 Less: net income attributable to non-controlling interest 2 — Comprehensive income attributable to Leidos common stockholders $ 207 $ 214 See accompanying notes to condensed consolidated financial statements. 3 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED) Shares of common stock Additional paid-in capital Retained earnings Accumulated other comprehensive income Leidos Holdings, Inc. stockholders' equity Non-controlling interest Total (in millions, except for per share amounts) Balance at December 31, 2021 140 $ 2,423 $ 1,880 $ ( 12 ) $ 4,291 $ 53 $ 4,344 Net income — — 175 — 175 2 177 Other comprehensive income, net of taxes — — — 32 32 — 32 Issuances of stock 1 15 — — 15 — 15 Repurchases of stock and other ( 4 ) ( 526 ) — — ( 526 ) — ( 526 ) Dividends of $ 0.36 per share — — ( 48 ) — ( 48 ) — ( 48 ) Stock-based compensation — 16 — — 16 — 16 Capital distributions to non-controlling interests — — — — — ( 2 ) ( 2 ) Balance at April 1, 2022 137 $ 1,928 $ 2,007 $ 20 $ 3,955 $ 53 $ 4,008 Shares of common stock Additional paid-in capital Retained earnings Accumulated other comprehensive loss Leidos Holdings, Inc. stockholders' equity Non-controlling interest Total (in millions, except for per share amounts) Balance at January 1, 2021 142 $ 2,580 $ 1,328 $ ( 46 ) $ 3,862 $ 9 $ 3,871 Net income — — 205 — 205 — 205 Other comprehensive income, net of taxes — — — 9 9 — 9 Issuances of stock — 14 — — 14 — 14 Repurchases of stock and other ( 1 ) ( 123 ) — — ( 123 ) — ( 123 ) Dividends of $ 0.34 per share — — ( 49 ) — ( 49 ) — ( 49 ) Stock-based compensation — 15 — — 15 — 15 Capital contributions from non-controlling interest — — — — — 38 38 Balance at April 2, 2021 141 $ 2,486 $ 1,484 $ ( 37 ) $ 3,933 $ 47 $ 3,980 See accompanying notes to condensed consolidated financial statements. 4 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three Months Ended April 1, 2022 April 2, 2021 (in millions) Cash flows from operations: Net income $ 177 $ 205 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization 85 77 Stock-based compensation 16 15 Deferred income taxes ( 61 ) — Other 4 ( 8 ) Change in assets and liabilities, net of effects of acquisitions: Receivables ( 232 ) ( 10 ) Other current assets and other long-term assets ( 28 ) 5 Accounts payable and accrued liabilities and other long-term liabilities ( 60 ) ( 148 ) Accrued payroll and employee benefits 124 50 Income taxes receivable/payable 68 53 Net cash provided by operating activities 93 239 Cash flows from investing activities: Acquisition of businesses, net of cash acquired ( 2 ) ( 218 ) Divestiture of a business 9 — Payments for property, equipment and software ( 28 ) ( 26 ) Net cash used in investing activities ( 21 ) ( 244 ) Cash flows from financing activities: Net proceeds from commercial paper 75 — Payments of long-term debt ( 27 ) ( 26 ) Dividend payments ( 51 ) ( 50 ) Repurchases of stock and other ( 526 ) ( 123 ) Net capital (distribution to) contributions from non-controlling interests ( 2 ) 38 Proceeds from issuances of stock 12 13 Net cash used in financing activities ( 519 ) ( 148 ) Net decrease in cash, cash equivalents and restricted cash ( 447 ) ( 153 ) Cash, cash equivalents and restricted cash at beginning of period 875 687 Cash, cash equivalents and restricted cash at end of period 428 534 Less: restricted cash at end of period 131 157 Cash and cash equivalents at end of period $ 297 $ 377 Supplementary cash flow information: Cash paid for income taxes, net of refunds $ 8 $ 8 Cash paid for interest 38 35 Non-cash investing activity: Property, plant and equipment additions $ 2 $ — Non-cash financing activity: Finance lease obligations $ — $ 45 See accompanying notes to condensed consolidated financial statements. 5 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1–Basis of Presentation and Summary of Significant Accounting Policies Nature of Operations and Basis of Presentation Leidos Holdings, Inc. ("Leidos"), a Delaware corporation, is a holding company whose direct 100%-owned subsidiary and principal operating company is Leidos, Inc. Leidos is a FORTUNE 500 ® 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 a controlling interest in Mission Support Alliance, LLC ("MSA"), a joint venture with Centerra Group, LLC. We also have a controlling interest in Hanford Mission Integration Solutions, LLC ("HMIS"), the legal entity for the follow-on contract to MSA's contract and a joint venture with Centerra Group, LLC and Parsons Government Services, Inc. The financial results for MSA and HMIS are consolidated into our unaudited condensed consolidated financial statements. The unaudited condensed consolidated financial statements also include the balances of all voting interest entities in which Leidos has a controlling voting interest ("subsidiaries") and a variable interest entity ("VIE") in which Leidos is the primary beneficiary. The consolidated balances of the VIE are not material to the unaudited condensed consolidated financial statements for the periods presented. Intercompany accounts and transactions between consolidated companies have been eliminated in consolidation. The accompanying unaudited condensed financial information has been prepared in accordance with the rules of the U.S. Securities and Exchange Commission and accounting principles generally accepted in the United States of America ("GAAP"). Certain disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Management evaluates these estimates and assumptions on an ongoing basis, including those relating to estimated profitability of long-term contracts, indirect billing rates, allowances for doubtful accounts, inventories, right-of-use assets and lease liabilities, fair value and impairment of intangible assets and goodwill, income taxes, stock-based compensation expense and contingencies. These estimates have been prepared by management on the basis of the most current and best available information; however, actual results could differ materially from those estimates. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which consist of normal recurring adjustments, necessary for a fair presentation thereof. The results reported in these unaudited condensed consolidated financial statements are not necessarily indicative of the results that may be expected for the entire year. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K filed on February 15, 2022. 6 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Accounting Standards Updates ("ASU") Adopted 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 adopted 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 with ASC 606. Accounting Standards Updates Issued But Not Yet Adopted ASU 2020-04 and ASU 2021-01, Reference Rate Reform (Topic 848) In March 2020, the FASB issued ASU 2020-04 which provides companies with optional expedients and exceptions to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. This update provides optional expedients for applying accounting guidance to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate ("LIBOR") or another reference rate expected to be discontinued because of the reference rate reform. The amendments in this update are effective for all entities as of March 2020 and can be adopted using a prospective approach no later than December 31, 2022. In January 2021, the FASB issued ASU 2021-01 which amends the scope of ASU 2020-04. The amendments in this update are elective and provide optional relief for entities with hedge accounting and contract modifications affected by the discounting transition through December 31, 2022. Under this relief, entities may continue to account for contract modifications as a continuation of the existing contract and the continuation of the hedge accounting arrangement. We are currently evaluating the impacts of reference rate reform. We currently use the one-month LIBOR for which the rate publication will cease in June 2023. Changes in Estimates on Contracts Changes in estimates related to contracts accounted for using the cost-to-cost method of accounting are recognized in the period in which such changes are made for the inception-to-date effect of the changes, with the exception of contracts acquired through a business combination, where the adjustment is made for the period commencing from the date of acquisition. Changes in estimates on contracts were as follows: Three Months Ended April 1, 2022 April 2, 2021 (in millions, except per share amounts) Favorable impact $ 41 $ 31 Unfavorable impact ( 26 ) ( 19 ) Net impact to income before income taxes $ 15 $ 12 Impact on diluted EPS attributable to Leidos common stockholders $ 0.08 $ 0.06 The impact on diluted earnings per share ("EPS") attributable to Leidos common stockholders is calculated using the statutory tax rate. 7 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Revenue Recognized from Prior Obligations Revenue recognized from performance obligations satisfied in previous periods was $ 14 million and $ 9 million for the three months ended April 1, 2022, and April 2, 2021, respectively. The changes primarily related to revisions of variable consideration including award and incentive fees, and revisions to estimates at completion resulting from changes in contract scope, mitigation of contract risks or true-ups of contract estimates at the end of contract performance. Cash and Cash Equivalents Our cash equivalents are primarily comprised of investments in several large institutional money market accounts, with original maturity of three months or less. At April 1, 2022, and December 31, 2021, $ 176 million and $ 138 million, respectively, of outstanding payments were included within "Cash and cash equivalents" and "Accounts payable and accrued liabilities" correspondingly on the condensed consolidated balance sheets. Restricted Cash We have restricted cash balances, primarily representing advances from customers that are restricted for use on certain expenditures related to that customer's contract and cash collected from the sale of accounts receivable but not yet remitted to the financial institution (see Note 9–Sale of Accounts Receivable). Restricted cash balances are included as "Other current assets" in the condensed consolidated balance sheets. Our restricted cash balances were $ 131 million and $ 148 million at April 1, 2022, and December 31, 2021, respectively. Note 2–Revenues from Contracts with Customers Remaining Performance Obligations Remaining performance obligations ("RPO") represent the expected value of exercised contracts, both funded and unfunded, less revenue recognized to date. Remaining performance obligations do not include unexercised option periods and future potential task orders expected to be awarded under indefinite delivery/indefinite quantity ("IDIQ") contracts, General Services Administration Schedule or other master agreement contract vehicles, with the exception of certain IDIQ contracts where task orders are not competitively awarded and separately priced but instead are used as a funding mechanism, and where there is a basis for estimating future revenues and funding on future anticipated task orders. As of April 1, 2022, we had $ 15.4 billion of RPO and expect to recognize approximately 55 % and 73 % over the next 12 months and 24 months, respectively, with the remainder to be recognized thereafter. Disaggregation of Revenues We disaggregate revenues by customer-type, contract-type and geographic location for each of our reportable segments. These categories represent how the nature, timing and uncertainty of revenues and cash flows are affected. 8 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Disaggregated revenues by customer-type were as follows: Three Months Ended April 1, 2022 Defense Solutions Civil Health Total (in millions) DoD and U.S. Intelligence Community $ 1,539 $ 20 $ 238 $ 1,797 Other government agencies (1) 222 613 385 1,220 Commercial and non-U.S. customers 287 147 27 461 Total $ 2,048 $ 780 $ 650 $ 3,478 Three Months Ended April 2, 2021 Defense Solutions Civil Health Total (in millions) DoD and U.S. Intelligence Community $ 1,407 $ 13 $ 158 $ 1,578 Other government agencies (1) 272 605 407 1,284 Commercial and non-U.S. customers 278 125 26 429 Total $ 1,957 $ 743 $ 591 $ 3,291 (1) Includes federal government agencies other than the DoD and U.S. Intelligence Community, as well as state and local government agencies. Disaggregated revenues by contract-type were as follows: Three Months Ended April 1, 2022 Defense Solutions Civil Health Total (in millions) Cost-reimbursement and fixed-price-incentive-fee $ 1,183 $ 408 $ 167 $ 1,758 Firm-fixed-price 618 255 417 1,290 Time-and-materials and fixed-price-level-of-effort 247 117 66 430 Total $ 2,048 $ 780 $ 650 $ 3,478 Three Months Ended April 2, 2021 Defense Solutions Civil Health Total (in millions) Cost-reimbursement and fixed-price-incentive-fee $ 1,163 $ 374 $ 99 $ 1,636 Firm-fixed-price 553 262 392 1,207 Time-and-materials and fixed-price-level-of-effort 241 107 100 448 Total $ 1,957 $ 743 $ 591 $ 3,291 9 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Disaggregated revenues by geographic location were as follows: Three Months Ended April 1, 2022 Defense Solutions Civil Health Total (in millions) United States $ 1,810 $ 741 $ 650 $ 3,201 International 238 39 — 277 Total $ 2,048 $ 780 $ 650 $ 3,478 Three Months Ended April 2, 2021 Defense Solutions Civil Health Total (in millions) United States $ 1,713 $ 704 $ 591 $ 3,008 International 244 39 — 283 Total $ 1,957 $ 743 $ 591 $ 3,291 Revenues by customer-type, contract-type and geographic location exclude lease income of $ 16 million and $ 24 million for the three months ended April 1, 2022 and April 2, 2021, respectively. Contract Assets and Liabilities Performance obligations are satisfied either over time as work progresses or at a point in time. Firm-fixed-price contracts are typically billed to the customer using milestone payments while cost-reimbursable and time and materials contracts are typically billed to the customer on a monthly or bi-weekly basis as indicated by the negotiated billing terms and conditions of the contract. As a result, the timing of revenue recognition, customer billings and cash collections for each contract results in a net contract asset or liability at the end of each reporting period. Contract assets consist of unbilled receivables, which is the amount of revenue recognized that exceeds the amount billed to the customer, where right to payment is not solely subject to the passage of time. Unbilled receivables exclude amounts billable where the right to consideration is unconditional. Contract liabilities consist of deferred revenue, which represents cash advances received prior to performance for programs and billings in excess of revenue recognized. The components of contract assets and contract liabilities consisted of the following: Balance sheet line item April 1, 2022 December 31, 2021 (in millions) Contract assets - current: Unbilled receivables Receivables, net $ 1,078 $ 1,022 Contract liabilities - current: Deferred revenue (1) Accounts payable and accrued liabilities $ 382 $ 364 Contract liabilities - non-current: Deferred revenue (1) Other long-term liabilities $ 25 $ 24 (1) Certain contracts record revenue net of cost of revenues, 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. Revenue recognized for the three months ended April 1, 2022, of $ 188 million was included as a contract liability at December 31, 2021. Revenue recognized for the three months ended April 2, 2021, of $ 144 million was included as a contract liability at January 1, 2021. 10 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 3–Acquisitions, Divestitures, Goodwill and Intangible Assets Business Acquisitions 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. As of April 1, 2022, we had completed the determination of fair values of the acquired assets and liabilities assumed. The final 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 For the three months ended April 1, 2022, $ 27 million of revenues related to the Gibbs & Cox acquisition 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, we recognized an $ 8 million program intangible asset and preliminary goodwill of $ 25 million. Aviation & Missile Solutions LLC ("AMS") Divestiture 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 net sales price is $ 15 million, and the divestiture was completed on April 29, 2022. 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 1, 2021 $ 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 $ 3,681 $ 2,097 $ 966 $ 6,744 Acquisition of a business 1 — — 1 Divestiture of a business ( 4 ) — — ( 4 ) Foreign currency translation adjustments 8 ( 7 ) — 1 Goodwill at April 1, 2022 $ 3,686 $ 2,090 $ 966 $ 6,742 As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021, the estimated fair value of the Security Products reporting unit within the Civil reportable segment exceeded the carrying value by approximately 6 % as of the most recent assessment date. 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. During the three months ended April 1, 2022, and April 2, 2021, there were no impairments to goodwill. 11 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Intangible Assets Intangible assets, net consisted of the following: April 1, 2022 December 31, 2021 Gross carrying value Accumulated amortization Net carrying value Gross carrying value Accumulated amortization Net carrying value (in millions) Finite-lived intangible assets: Programs $ 1,701 $ ( 866 ) $ 835 $ 1,722 $ ( 830 ) $ 892 Software and technology 230 ( 127 ) 103 230 ( 121 ) 109 Customer relationships 91 ( 16 ) 75 97 ( 18 ) 79 Backlog 6 ( 6 ) — 38 ( 37 ) 1 Trade names 1 ( 1 ) — 1 ( 1 ) — Total finite-lived intangible assets 2,029 ( 1,016 ) 1,013 2,088 ( 1,007 ) 1,081 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 $ 2,125 $ ( 1,016 ) $ 1,109 $ 2,184 $ ( 1,007 ) $ 1,177 Amortization expense was $ 59 million and $ 55 million for the three months ended April 1, 2022 and April 2, 2021, respectively. Program intangible assets are amortized over their respective estimated useful lives in proportion to the pattern of economic benefit based on expected future discounted cash flows. Backlog and trade name intangible assets are amortized on a straight-line basis over their estimated useful lives. Customer relationships and software and technology intangible assets are amortized either on a straight-line basis over their estimated useful lives or over their respective estimated useful lives in proportion to the pattern of economic benefit based on expected future discounted cash flows, as deemed appropriate. The estimated annual amortization expense as of April 1, 2022, was as follows: Fiscal year ending (in millions) 2022 (remainder of year) $ 173 2023 203 2024 150 2025 120 2026 96 2027 and thereafter 271 $ 1,013 12 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 4–Fair Value Measurements The accounting standard for fair value measurements establishes a three-level fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: observable inputs such as quoted prices in active markets (Level 1); inputs other than quoted prices in active markets that are observable, either directly or indirectly, or quoted prices that are not active (Level 2); and unobservable inputs in which there is little or no market data (e.g., discounted cash flow and other similar pricing models), which requires us to develop our own assumptions about the assumptions that market participants would use in pricing the asset or liability (Level 3). The financial instruments measured at fair value on a recurring basis primarily consisted of the following: April 1, 2022 December 31, 2021 Carrying value Fair value Carrying value Fair value (in millions) Financial liabilities: Derivatives $ 13 $ 13 $ 53 $ 53 As of April 1, 2022, 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 5–Derivative Instruments"). The fair value of the cash flow interest rate swaps is determined based on observed values for underlying interest rates on the LIBOR yield curve and the underlying interest rate (Level 2 inputs). The carrying amounts of our financial instruments, other than derivatives, which include cash equivalents, accounts receivable, accounts payable and accrued expenses, are reasonable estimates of their related fair values. As of April 1, 2022, and December 31, 2021, the fair value of debt was $ 5.1 billion and $ 5.4 billion, respectively, and the carrying amount was $ 5.1 billion and $ 5.1 billion, respectively (see "Note 6–Debt"). The fair value of long-term debt is determined based on current interest rates available for debt with terms and maturities similar to our existing debt arrangements (Level 2 inputs). On May 7, 2021, and January 14, 2021, non-financial instruments measured at fair value on a non-recurring basis were recorded in connection with the acquisitions of Gibbs & Cox and 1901 Group. The fair values of the assets acquired and liabilities assumed were determined using Level 3 inputs. As of April 1, 2022, we did not have any assets or liabilities measured at fair value on a non-recurring basis. 13 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 5–Derivative Instruments We manage our risk to changes in interest rates through the use of derivative instruments. We do not hold derivative instruments for trading or speculative purposes. For variable rate borrowings, we use fixed interest rate swaps, effectively converting a portion of the variable interest rate payments to fixed interest rate payments. These swaps are designated as cash flow hedges. The fair value of the interest rate swaps was as follows: Liability derivatives Balance sheet line item April 1, 2022 December 31, 2021 (in millions) Cash flow interest rate swaps Other long-term liabilities $ 13 $ 53 The cash flows associated with the interest rate swaps are classified as operating activities in the condensed consolidated statements of cash flows. Cash Flow Hedges We have interest rate swap agreements to hedge the cash flows of $ 1.0 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 swaps is reported as a component of other comprehensive income (loss) and is reclassified into earnings when the interest payments on the underlying hedged items impact earnings. A qualitative assessment of hedge effectiveness is performed on a quarterly basis, unless facts and circumstances indicate the hedge may no longer be highly effective. The effect of the cash flow hedges on other comprehensive income (loss) and earnings for the periods presented was as follows: Three Months Ended April 1, 2022 April 2, 2021 (in millions) Total interest expense, net presented in the condensed consolidated statements of income in which the effects of cash flow hedges are recorded $ 48 $ 45 Amount recognized in other comprehensive income $ 32 $ 12 Amount reclassified from accumulated other comprehensive income (loss) to interest expense, net $ 6 $ 5 We expect to reclassify net losses of $ 15 million from accumulated other comprehensive income into earnings during the next 12 months. 14 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 6–Debt Our debt consisted of the following: Stated interest rate Effective interest rate April 1, 2022 (1) December 31, 2021 (1) (in millions) Short-term debt: Commercial paper 0.52 %- 1.13 % Various $ 75 $ — Senior unsecured term loans: $ 380 million term loan, due May 2022 1.59 % 1.69 % 380 380 Total short-term debt $ 455 $ 380 Long-term debt: Senior unsecured term loans: $ 1,925 million term loan, due January 2025 1.84 % 2.11 % $ 1,275 $ 1,298 Senior unsecured notes: $ 500 million notes, due May 2023 2.95 % 3.17 % 499 498 $ 500 million notes, due May 2025 3.63 % 3.76 % 497 497 $ 750 million notes due May 2030 4.38 % 4.50 % 738 738 $ 1,000 million notes, due February 2031 2.30 % 2.38 % 990 990 $ 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 50 54 Total long-term debt 4,670 4,696 Less current portion ( 101 ) ( 103 ) Total long-term debt, net of current portion $ 4,569 $ 4,593 (1) The carrying amounts of the senior unsecured term loans and notes as of April 1, 2022, and December 31, 2021, include the remaining principal outstanding of $ 5,041 million and $ 5,065 million, respectively, less total unamortized debt discounts and deferred debt issuances costs of $ 41 million and $ 43 million, respectively. Term Loans and Revolving Credit Facility We have a Credit Agreement (the "Credit Agreement") with certain financial institutions, which provided for a senior unsecured term loan facility in an aggregate principal amount of $ 1.9 billion (the "Term Loan Facility") and a $ 750 million senior unsecured revolving facility (the "Revolving Facility" and, together with the Term Loan Facility, the "Credit Facilities"). The Credit Facilities will mature in January 2025. The Revolving Facility permits two additional one-year extensions subject to lender consent. 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. 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. 15 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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. Commercial Paper We have 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 are issued in minimum denominations of $ 0.25 million and have maturities of up to 397 days from the date of issuance. The Commercial Paper Notes either bear a stated or floating interest rate, if interest bearing, or will be sold at a discount from the face amount. As of April 1, 2022, we had $ 75 million of Commercial Paper Notes outstanding. Principal Payments and Debt Issuance Costs We made principal payments on our long-term debt of $ 27 million and $ 26 million during the three months ended April 1, 2022, and April 2, 2021, respectively. This activity included required principal payments on our term loans of $ 24 million for both the three months ended April 1, 2022, and April 2, 2021. As of April 1, 2022, and December 31, 2021, there were no borrowings outstanding under the Revolving Facility. Amortization of debt discount and debt issuance costs was $ 3 million and $ 2 million for the three months ended April 1, 2022, and April 2, 2021, respectively. The Credit Facilities, the 2021 Credit Agreement, Commercial Paper Notes, senior unsecured term loans and notes are fully and unconditionally guaranteed and contain certain customary restrictive covenants, including among other things, restrictions on our ability to create liens and enter into sale and leaseback transactions under certain circumstances. We were in compliance with all covenants as of April 1, 2022. Note 7–Accumulated Other Comprehensive Income (Loss) Changes in the components of accumulated other comprehensive income (loss) were as follows: Foreign currency translation adjustments Unrecognized gain (loss) on derivative instruments Pension adjustments Total accumulated other comprehensive income (loss) (in millions) 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 income (loss) — 19 — 19 Balance at December 31, 2021 22 ( 41 ) 7 ( 12 ) Other comprehensive income (loss) ( 2 ) 32 1 31 Taxes 4 ( 9 ) — ( 5 ) Reclassification from accumulated other comprehensive income (loss) — 6 — 6 Balance at April 1, 2022 $ 24 $ ( 12 ) $ 8 $ 20 Reclassifications from unrecognized loss on derivative instruments are recorded in "Interest expense, net" in the condensed consolidated statements of income. 16 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 8–Earnings Per Share The following table provides a reconciliation of the weighted average number of shares outstanding used to compute basic and diluted EPS for the periods presented: Three Months Ended April 1, 2022 April 2, 2021 (in millions) Basic weighted average number of shares outstanding 139 142 Dilutive common share equivalents—stock options and other stock awards 1 2 Diluted weighted average number of shares outstanding 140 144 Anti-dilutive stock-based awards are excluded from the weighted average number of shares outstanding used to compute diluted EPS. The total outstanding stock options and vesting stock awards that were anti-dilutive were 1 million for both the three months ended April 1, 2022, and April 2, 2021. On February 16, 2022, we entered into an Accelerated Share Repurchase ("ASR") agreement with a financial institution to repurchase shares of our outstanding common stock. We paid $ 500 million to the financial institution and received an initial delivery of 4.5 million shares at an average price of $ 88.72 per share. The purchase was recorded to "Additional paid-in capital" in the condensed consolidated balance sheets. All shares delivered were immediately retired. The specific number of shares that we will ultimately receive under the ASR agreement will be based on the volume-weighted-average-price during the period February 17, 2022, to May 16, 2022. Note 9–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 the three months ended April 1, 2022, and April 2, 2021, we sold $ 209 million and $ 465 million, respectively, of accounts receivable under the agreements and received proceeds of $ 209 million and $ 464 million, respectively, which were classified as operating activities in the condensed 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. Our only continuing involvement with the transferred financial assets is as the collection and servicing agent. As a result, the accounts receivable balance on the condensed consolidated balance sheets is presented net of the transferred amounts. No servicing asset or liability was recognized for continued servicing of the sold receivables, as the servicing fee approximates fair value. 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 condensed consolidated statements of income. Sold receivables activity for the periods presented was as follows: Three Months Ended April 1, 2022 April 2, 2021 (in millions) Sales of accounts receivable $ 209 $ 465 Cash collections on sold receivables remitted to financial institution ( 209 ) ( 371 ) Outstanding balance sold to financial institution — 94 Cash collected but not yet remitted to financial institution — ( 19 ) Sold receivables due from customers $ — $ 75 17 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 10–Business Segments Our operations and reportable segments are organized around the customers and markets we serve. We define our reportable segments based on the way the chief operating decision maker ("CODM"), currently our Chairman and Chief Executive Officer, manages operations for the purposes of allocating resources and assessing performance. The segment information for the periods presented was as follows: Three Months Ended April 1, 2022 April 2, 2021 (in millions) Revenues: Defense Solutions $ 2,049 $ 1,958 Civil 795 766 Health 650 591 Total revenues $ 3,494 $ 3,315 Operating income (loss): Defense Solutions $ 133 $ 152 Civil 43 74 Health 118 102 Corporate ( 23 ) ( 20 ) Total operating income $ 271 $ 308 The income statement performance measures used to evaluate segment performance are revenues and operating income. As a result, "Interest expense, net," "Other expense, net" and "Income tax expense" as reported in the condensed consolidated statements of income are not allocated to our segments. Under U.S. Government Cost Accounting Standards, indirect costs including depreciation expense are collected in indirect cost pools, which are then collectively allocated to the reportable segments based on a representative causal or beneficial relationship of the costs in the pool to the costs in the base. As such, depreciation expense is not separately disclosed on the condensed consolidated statements of income. Asset information by segment is not a key measure of performance used by the CODM. 18 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 11–Commitments and Contingencies 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 April 1, 2022, active indirect cost audits by the Defense Contract Audit Agency remain open for fiscal 2016 and subsequent fiscal years. Although we have recorded contract revenues based upon an estimate of costs that we believe will be approved upon final audit or review, we cannot predict the outcome of any ongoing or future audits or reviews and adjustments, and if future adjustments exceed estimates, our profitability may be adversely affected. As of April 1, 2022, we believe we have adequately reserved for potential adjustments from audits or reviews of contract costs. 19 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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 $ 51 million as of April 1, 2022, principally related to performance guarantees on contracts. We also have outstanding surety bonds with a notional amount of $ 100 million, principally related to performance and subcontractor payment bonds on contracts. The value of the surety bonds may vary due to changes in the underlying project status and/or contractual modifications. As of April 1, 2022, the future expirations of the outstanding letters of credit and surety bonds were as follows: Fiscal year ending (in millions) 2022 (remainder of year) $ 38 2023 11 2024 81 2025 5 2026 2 2027 and thereafter 14 $ 151 20 Table of Contents LEIDOS HOLDINGS, INC.