Leidos Holdings, Inc. 10-Q

Item 1. Financial Statements. LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) September 30, 2022 December 31, 2021 (in millions) Assets: Cash and cash equivalents $ 807 $ 727 Receivables, net 2,284 2,189 Inventory, net 286 274 Other current assets 464 429 Total current assets 3,841 3,619 Property, plant and equipment, net 671 670 Intangible assets, net 977 1,177 Goodwill 6,618 6,744 Operating lease right-of-use assets, net 593 612 Other long-term assets 399 439 Total assets $ 13,099 $ 13,261 Liabilities: Accounts payable and accrued liabilities $ 2,301 $ 2,141 Accrued payroll and employee benefits 813 605 Short-term debt and current portion of long-term debt 1,027 483 Total current liabilities 4,141 3,229 Long-term debt, net of current portion 3,975 4,593 Operating lease liabilities 591 589 Deferred tax liabilities 24 239 Other long-term liabilities 229 267 Total liabilities 8,960 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 September 30, 2022, and December 31, 2021, respectively — — Additional paid-in capital 1,982 2,423 Retained earnings 2,239 1,880 Accumulated other comprehensive loss ( 135 ) ( 12 ) Total Leidos stockholders’ equity 4,086 4,291 Non-controlling interest 53 53 Total stockholders' equity 4,139 4,344 Total liabilities and stockholders' equity $ 13,099 $ 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 Nine Months Ended September 30, 2022 October 1, 2021 September 30, 2022 October 1, 2021 (in millions, except per share amounts) Revenues $ 3,608 $ 3,483 $ 10,699 $ 10,246 Cost of revenues 3,095 2,942 9,136 8,740 Selling, general and administrative expenses 233 233 727 625 Bad debt expense (recoveries) ( 1 ) ( 1 ) 3 ( 11 ) Acquisition, integration and restructuring costs 4 6 12 21 Asset impairment charges — 3 3 3 Equity earnings of non-consolidated subsidiaries ( 4 ) ( 5 ) ( 5 ) ( 14 ) Operating income 281 305 823 882 Non-operating expense: Interest expense, net ( 50 ) ( 47 ) ( 148 ) ( 138 ) Other (expense) income, net ( 10 ) 2 ( 7 ) 1 Income before income taxes 221 260 668 745 Income tax expense ( 57 ) ( 52 ) ( 155 ) ( 162 ) Net income $ 164 $ 208 $ 513 $ 583 Less: net income attributable to non-controlling interest 2 3 5 4 Net income attributable to Leidos common stockholders $ 162 $ 205 $ 508 $ 579 Earnings per share: Basic $ 1.18 $ 1.45 $ 3.71 $ 4.11 Diluted 1.17 1.43 3.68 4.05 See accompanying notes to condensed consolidated financial statements. 2 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) Three Months Ended Nine Months Ended September 30, 2022 October 1, 2021 September 30, 2022 October 1, 2021 (in millions) Net income $ 164 $ 208 $ 513 $ 583 Foreign currency translation adjustments ( 75 ) ( 29 ) ( 158 ) ( 12 ) Unrecognized gain on derivative instruments 18 4 54 18 Pension adjustments 1 — ( 19 ) — Total other comprehensive (loss) income, net of taxes ( 56 ) ( 25 ) ( 123 ) 6 Comprehensive income 108 183 390 589 Less: net income attributable to non-controlling interest 2 3 5 4 Comprehensive income attributable to Leidos common stockholders $ 106 $ 180 $ 385 $ 585 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 (loss) Leidos stockholders' equity Non-controlling interest Total stockholders' equity (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 interest — — — — — ( 2 ) ( 2 ) Balance at April 1, 2022 137 $ 1,928 $ 2,007 $ 20 $ 3,955 $ 53 $ 4,008 Net income — — 171 — 171 1 172 Other comprehensive loss, net of taxes — — — ( 99 ) ( 99 ) — ( 99 ) Issuances of stock — 10 — — 10 — 10 Repurchases of stock and other — ( 2 ) — — ( 2 ) — ( 2 ) Dividends of $ 0.36 per share — — ( 50 ) — ( 50 ) — ( 50 ) Stock-based compensation — 19 — — 19 — 19 Capital distributions to non-controlling interest — — — — — ( 1 ) ( 1 ) Balance at July 1, 2022 137 $ 1,955 $ 2,128 $ ( 79 ) $ 4,004 $ 53 $ 4,057 Net income — — 162 — 162 2 164 Other comprehensive loss, net of taxes — — — ( 56 ) ( 56 ) — ( 56 ) Issuances of stock — 13 — — 13 — 13 Repurchases of stock and other — ( 4 ) — — ( 4 ) — ( 4 ) Dividends of $ 0.36 per share — — ( 51 ) — ( 51 ) — ( 51 ) Stock-based compensation — 18 — — 18 — 18 Capital distributions to non-controlling interest — — — — — ( 2 ) ( 2 ) Balance at September 30, 2022 137 $ 1,982 $ 2,239 $ ( 135 ) $ 4,086 $ 53 $ 4,139 See accompanying notes to condensed consolidated financial statements. 4 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED) Shares of common stock Additional paid-in capital Retained earnings Accumulated other comprehensive income (loss) Leidos stockholders' equity Non-controlling interest Total stockholders' equity (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 Net income — — 169 — 169 1 170 Other comprehensive income, net of taxes — — — 22 22 — 22 Issuances of stock 1 9 — — 9 — 9 Repurchases of stock and other — ( 3 ) — — ( 3 ) — ( 3 ) Dividends of $ 0.34 per share — — ( 48 ) — ( 48 ) — ( 48 ) Stock-based compensation — 17 — — 17 — 17 Capital contributions from non-controlling interest — — — — — 1 1 Balance at July 2, 2021 142 $ 2,509 $ 1,605 $ ( 15 ) $ 4,099 $ 49 $ 4,148 Net income — — 205 — 205 3 208 Other comprehensive loss, net of taxes — — — ( 25 ) ( 25 ) — ( 25 ) Issuances of stock — 11 — — 11 — 11 Repurchases of stock and other ( 2 ) ( 140 ) — — ( 140 ) — ( 140 ) Dividends of $ 0.36 per share — — ( 52 ) — ( 52 ) — ( 52 ) Stock-based compensation — 17 — — 17 — 17 Net capital distributions to non-controlling interest — — — — — ( 1 ) ( 1 ) Balance at October 1, 2021 140 $ 2,397 $ 1,758 $ ( 40 ) $ 4,115 $ 51 $ 4,166 See accompanying notes to condensed consolidated financial statements. 5 Table of Contents LEIDOS HOLDINGS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Nine Months Ended September 30, 2022 October 1, 2021 (in millions) Cash flows from operations: Net income $ 513 $ 583 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization 249 244 Stock-based compensation 53 49 Asset impairment charges 3 3 Deferred income taxes ( 221 ) 4 Other 21 ( 11 ) Change in assets and liabilities, net of effects of acquisitions: Receivables ( 138 ) ( 103 ) Other current assets and other long-term assets 132 161 Accounts payable and accrued liabilities and other long-term liabilities ( 57 ) ( 172 ) Accrued payroll and employee benefits 217 83 Income taxes receivable/payable 109 ( 20 ) Net cash provided by operating activities 881 821 Cash flows from investing activities: Acquisition of businesses, net of cash acquired ( 2 ) ( 622 ) Divestiture of a business 15 — Payments for property, equipment and software ( 76 ) ( 71 ) Net proceeds from sale of assets 6 — Other 2 — Net cash used in investing activities ( 55 ) ( 693 ) Cash flows from financing activities: Proceeds from debt issuance 380 380 Repayments of borrowings ( 459 ) ( 80 ) Dividend payments ( 149 ) ( 149 ) Repurchases of stock and other ( 532 ) ( 266 ) Net capital (distributions to) contributions from non-controlling interests ( 5 ) 38 Proceeds from issuances of stock 35 33 Net cash used in financing activities ( 730 ) ( 44 ) Net increase in cash, cash equivalents and restricted cash 96 84 Cash, cash equivalents and restricted cash at beginning of period 875 687 Cash, cash equivalents and restricted cash at end of period 971 771 Less: restricted cash at end of period 164 184 Cash and cash equivalents at end of period $ 807 $ 587 Supplementary cash flow information: Cash paid for income taxes, net of refunds $ 166 $ 179 Cash paid for interest 136 128 Non-cash investing activity: Property, plant and equipment additions $ 7 $ 1 Non-cash financing activity: Finance lease obligations $ 1 $ 50 See accompanying notes to condensed consolidated financial statements. 6 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 1–Basis of Presentation and Summary of Significant Accounting Policies Nature of Operations and Basis of Presentation Leidos Holdings, Inc. ("Leidos"), a Delaware corporation, is a holding company whose direct 100%-owned subsidiary and principal operating company is Leidos, Inc. Leidos is a FORTUNE 500 ® 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. Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation. We combined "Capital distributions to non-controlling interests" and "Capital contributions from non-controlling interests" into "Net capital (distributions to) contributions from non-controlling interests" on the condensed consolidated statements of cash flows. 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. 7 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. In October 2022, the FASB affirmed a decision to defer the expiration date of this optional relief until December 31, 2024. We anticipate an ASU formalizing this decision to be approved and issued during the last quarter of fiscal 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 the reference rate reform. Except for our new $ 380 million term loan entered into on May 6, 2022 (see "Note 6–Debt"), 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 Nine Months Ended September 30, 2022 October 1, 2021 September 30, 2022 October 1, 2021 (in millions, except per share amounts) Favorable impact $ 36 $ 47 $ 116 $ 115 Unfavorable impact ( 29 ) ( 24 ) ( 75 ) ( 72 ) Net impact to income before income taxes $ 7 $ 23 $ 41 $ 43 Impact on diluted EPS attributable to Leidos common stockholders $ 0.03 $ 0.12 $ 0.22 $ 0.22 The impact on diluted earnings per share ("EPS") attributable to Leidos common stockholders is calculated using the statutory tax rate. 8 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 $ 6 million and $ 38 million for the three and nine months ended September 30, 2022, respectively, and $ 17 million and $ 35 million for the three and nine months ended October 1, 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 September 30, 2022, and December 31, 2021, $ 178 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. Restricted cash balances are included as "Other current assets" in the condensed consolidated balance sheets. Our restricted cash balances were $ 164 million and $ 148 million at September 30, 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. RPO does 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 September 30, 2022, we had $ 14.3 billion of RPO and expect to recognize approximately 60 % and 77 % 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. Disaggregated revenues by customer-type were as follows: Three Months Ended September 30, 2022 Nine Months Ended September 30, 2022 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) DoD and U.S. Intelligence Community $ 1,559 $ 22 $ 255 $ 1,836 $ 4,620 $ 62 $ 732 $ 5,414 Other U.S. government agencies (1) 236 676 372 1,284 686 1,949 1,177 3,812 Commercial and non-U.S. customers 280 151 28 459 869 446 83 1,398 Total $ 2,075 $ 849 $ 655 $ 3,579 $ 6,175 $ 2,457 $ 1,992 $ 10,624 9 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Three Months Ended October 1, 2021 Nine Months Ended October 1, 2021 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) DoD and U.S. Intelligence Community $ 1,513 $ 19 $ 203 $ 1,735 $ 4,386 $ 45 $ 545 $ 4,976 Other U.S. government agencies (1) 215 619 450 1,284 724 1,849 1,292 3,865 Commercial and non-U.S. customers 281 121 28 430 859 377 80 1,316 Total $ 2,009 $ 759 $ 681 $ 3,449 $ 5,969 $ 2,271 $ 1,917 $ 10,157 (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 September 30, 2022 Nine Months Ended September 30, 2022 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) Cost-reimbursement and fixed-price-incentive-fee $ 1,166 $ 442 $ 200 $ 1,808 $ 3,493 $ 1,293 $ 534 $ 5,320 Firm-fixed-price 668 279 389 1,336 1,950 792 1,260 4,002 Time-and-materials and fixed-price-level-of-effort 241 128 66 435 732 372 198 1,302 Total $ 2,075 $ 849 $ 655 $ 3,579 $ 6,175 $ 2,457 $ 1,992 $ 10,624 Three Months Ended October 1, 2021 Nine Months Ended October 1, 2021 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) Cost-reimbursement and fixed-price-incentive-fee $ 1,230 $ 397 $ 137 $ 1,764 $ 3,627 $ 1,176 $ 361 $ 5,164 Firm-fixed-price 540 245 443 1,228 1,619 755 1,254 3,628 Time-and-materials and fixed-price-level-of-effort 239 117 101 457 723 340 302 1,365 Total $ 2,009 $ 759 $ 681 $ 3,449 $ 5,969 $ 2,271 $ 1,917 $ 10,157 Disaggregated revenues by geographic location were as follows: Three Months Ended September 30, 2022 Nine Months Ended September 30, 2022 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) United States $ 1,830 $ 810 $ 655 $ 3,295 $ 5,429 $ 2,340 $ 1,992 $ 9,761 International 245 39 — 284 746 117 — 863 Total $ 2,075 $ 849 $ 655 $ 3,579 $ 6,175 $ 2,457 $ 1,992 $ 10,624 10 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Three Months Ended October 1, 2021 Nine Months Ended October 1, 2021 Defense Solutions Civil Health Total Defense Solutions Civil Health Total (in millions) United States $ 1,778 $ 726 $ 681 $ 3,185 $ 5,237 $ 2,158 $ 1,917 $ 9,312 International 231 33 — 264 732 113 — 845 Total $ 2,009 $ 759 $ 681 $ 3,449 $ 5,969 $ 2,271 $ 1,917 $ 10,157 Revenues by customer-type, contract-type and geographic location exclude lease income of $ 29 million and $ 75 million for the three and nine months ended September 30, 2022, respectively, and $ 34 million and $ 89 million for the three and nine months ended October 1, 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 September 30, 2022 December 31, 2021 (in millions) Contract assets - current: Unbilled receivables Receivables, net $ 1,028 $ 1,022 Contract liabilities - current: Deferred revenue (1) Accounts payable and accrued liabilities $ 450 $ 364 Contract liabilities - non-current: Deferred revenue (1) Other long-term liabilities $ 26 $ 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 deferred revenue was primarily due to the timing of advanced payments from customers offset by revenue recognized during the period. Revenue recognized for the three and nine months ended September 30, 2022, of $ 17 million and $ 257 million, respectively, was included as a contract liability at December 31, 2021. Revenue recognized for the three and nine months ended October 1, 2021, of $ 31 million and $ 253 million, respectively, was included as a contract liability at January 1, 2021. 11 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 3–Acquisitions, Divestitures, Goodwill and Intangible Assets Business Acquisitions On July 29, 2022, we entered into a definitive agreement to acquire Cobham Aviation Services Australia’s Special Mission business ("Cobham Special Mission") for a preliminary purchase consideration of $ 310 million Australian dollars, subject to working capital adjustments. Cobham Special Mission provides airborne border surveillance and search and rescue services to the Australian Federal Government. On September 21, 2021, we completed an immaterial strategic business acquisition for purchase consideration of approximately $ 36 million. In connection with the transaction, we recognized an $ 8 million program intangible asset and 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 was $ 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 Divestiture of a business ( 6 ) — — ( 6 ) Foreign currency translation adjustments ( 62 ) ( 58 ) — ( 120 ) Goodwill at September 30, 2022 $ 3,613 $ 2,039 $ 966 $ 6,618 We evaluate qualitative factors that could cause us to believe the estimated fair value of each of our reporting units may be lower than the carrying value and trigger a quantitative assessment, including, but not limited to (i) macroeconomic conditions, (ii) industry and market considerations, (iii) our overall financial performance, including an analysis of our current and projected cash flows, revenues and earnings, (iv) a sustained decrease in share price and (v) other relevant entity-specific events including changes in management, strategy, partners or litigation. 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 Enterprise Solutions 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 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. We did not identify any qualitative factors that would trigger a quantitative goodwill impairment test during the nine months ended September 30, 2022. There were no impairments to goodwill during the nine months ended September 30, 2022, and October 1, 2021. 12 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Intangible Assets Intangible assets, net consisted of the following: September 30, 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 $ 1,697 $ ( 967 ) $ 730 $ 1,722 $ ( 830 ) $ 892 Software and technology 218 ( 130 ) 88 230 ( 121 ) 109 Customer relationships 84 ( 21 ) 63 97 ( 18 ) 79 Backlog — — — 38 ( 37 ) 1 Trade names 1 ( 1 ) — 1 ( 1 ) — Total finite-lived intangible assets 2,000 ( 1,119 ) 881 2,088 ( 1,007 ) 1,081 Indefinite-lived intangible assets: In-process research and development ("IPR&D") (1) 92 — 92 92 — 92 Trade names 4 — 4 4 — 4 Total indefinite-lived intangible assets 96 — 96 96 — 96 Total intangible assets $ 2,096 $ ( 1,119 ) $ 977 $ 2,184 $ ( 1,007 ) $ 1,177 (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. Amortization expense was $ 57 million and $ 173 million for the three and nine months ended September 30, 2022, respectively, and $ 63 million and $ 173 million for the three and nine months ended October 1, 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 finite-lived 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 September 30, 2022, was as follows: Fiscal year ending (in millions) 2022 (remainder of year) $ 56 2023 199 2024 147 2025 119 2026 94 2027 and thereafter 266 $ 881 13 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: September 30, 2022 December 31, 2021 Carrying value Fair value Carrying value Fair value (in millions) Financial assets: Derivatives $ 20 $ 20 $ — $ — Financial liabilities: Derivatives $ 16 $ 16 $ 53 $ 53 As of September 30, 2022, our derivatives primarily consisted of the cash flow interest rate swaps on $ 1.0 billion of the variable rate senior unsecured term loan and a foreign currency forward contract (see "Note 5–Derivative Instruments"). The fair value of the cash flow interest rate swaps and the foreign currency forward contract is determined based on observed values for underlying interest rates on the LIBOR yield curve, the underlying interest rate and the underlying foreign exchange rates (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 September 30, 2022, and December 31, 2021, the fair value of debt was $ 4.6 billion and $ 5.4 billion, respectively, and the carrying amount was $ 5.0 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 completed acquisitions of Gibbs & Cox and 1901 Group, LLC. The fair values of the assets acquired and liabilities assumed were determined using Level 3 inputs. As of September 30, 2022, we did not have any assets or liabilities measured at fair value on a non-recurring basis. 14 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. We transact business globally and are subject to risks associated with changing foreign currency exchange rates. We enter into foreign currency forward contracts in order to mitigate fluctuations in our earnings and cash flows due to changing rates. The foreign currency forward contracts are not designated as hedges and do not qualify for hedge accounting. The fair value of the interest rate swaps and foreign currency forward contracts was as follows: Balance sheet line item September 30, 2022 December 31, 2021 (in millions) Asset derivatives: Cash flow interest rate swaps Other long-term assets $ 20 $ — Liability derivatives: Cash flow interest rate swaps Other long-term liabilities $ — $ 53 Foreign currency forward contracts Accounts payable and accrued liabilities 16 — During the three months ended September 30, 2022, we entered into a foreign currency forward contract to offset foreign currency fluctuations of the $ 310 million Australian dollar preliminary purchase price for the Cobham Special Mission acquisition against the U.S. dollar. As of September 30, 2022, we recorded a $ 16 million unrealized loss due to the exchange rate movements between the Australian dollar compared to the U.S. dollar. The loss was recorded within Corporate and presented in "Other (expense) income, net" on the condensed consolidated statements of income. 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. 15 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The effect of the cash flow hedges on other comprehensive income (loss) and earnings for the periods presented was as follows: Three Months Ended Nine Months Ended September 30, 2022 October 1, 2021 September 30, 2022 October 1, 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 $ 50 $ 47 $ 148 $ 138 Amount recognized in other comprehensive income (loss) $ 21 $ — $ 57 $ 9 Amount reclassified from accumulated other comprehensive income (loss) to interest expense, net $ 2 $ 5 $ 13 $ 14 We expect to reclassify net income of $ 13 million from accumulated other comprehensive loss into earnings during the next 12 months. Note 6–Debt Our debt consisted of the following: Stated interest rate Effective interest rate September 30, 2022 (1) December 31, 2021 (1) (in millions) Short-term debt: Senior unsecured term loans: $ 380 million term loan, due May 2022 1.54 % 1.64 % $ — $ 380 $ 380 million term loan, due May 2023 4.13 % 4.22 % 380 — Total short-term debt $ 380 $ 380 Long-term debt: Senior unsecured term loans: $ 1,925 million term loan, due January 2025 4.50 % 4.81 % $ 1,228 $ 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 % 498 497 $ 750 million notes due May 2030 4.38 % 4.50 % 739 738 $ 1,000 million notes, due February 2031 2.30 % 2.38 % 991 990 $ 250 million notes, due July 2032 7.13 % 7.43 % 247 247 $ 300 million notes, due July 2033 5.50 % 5.88 % 159 158 $ 300 million notes, due December 2040 5.95 % 6.03 % 216 216 Notes payable and finance leases due on various dates through fiscal 2032 1.84 %- 4.30 % Various 45 54 Total long-term debt 4,622 4,696 Less current portion ( 647 ) ( 103 ) Total long-term debt, net of current portion $ 3,975 $ 4,593 (1) The carrying amounts of the senior unsecured term loans and notes as of September 30, 2022, and December 31, 2021, include the remaining principal outstanding of $ 4,994 million and $ 5,065 million, respectively, less total unamortized debt discounts and deferred debt issuances costs of $ 37 million and $ 43 million, respectively. 16 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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. As of September 30, 2022, there were no borrowings outstanding under the Revolving Facility. Borrowings under the Credit Agreement bear interest at a rate determined, at our option, based on either an alternate base rate or a LIBOR rate plus, in each case, an applicable margin that varies depending on our credit rating. The applicable margin range for LIBOR-denominated borrowings is from 1.13 % to 1.75 %. Based on our current ratings, the applicable margin for LIBOR-denominated borrowings is 1.38 %. 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 6, 2022, we entered into a 364 -day term loan credit agreement ("Term Loan Agreement") with certain financial institutions, which provided for a senior unsecured term loan facility in an aggregate principal amount of $ 380 million. The proceeds of the Term Loan Agreement were used to repay the $ 380 million senior unsecured term loan entered into on May 7, 2021. Borrowings under the Term Loan Agreement bear interest at a rate based on the Secured Overnight Financing Rate plus 1.10 %, or an alternate base rate at our option. The financial covenants in the Term Loan 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 September 30, 2022, we had no Commercial Paper Notes outstanding. Principal Payments and Debt Issuance Costs We made principal payments on our long-term debt of $ 25 million and $ 459 million during the three and nine months ended September 30, 2022, respectively, and $ 27 million and $ 80 million during the three and nine months ended October 1, 2021, respectively. This activity included required principal payments on our term loans of $ 24 million and $ 452 million for the three and nine months ended September 30, 2022, and $ 24 million and $ 72 million for the three and nine months ended October 1, 2021, respectively. As of September 30, 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 $ 8 million for the three and nine months ended September 30, 2022, respectively, and $ 3 million and $ 7 million for the three and nine months ended October 1, 2021, respectively. The Credit Facilities, the Term Loan 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 September 30, 2022. 17 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note 7–Accumulated Other Comprehensive Income (Loss) Changes in the components of Accumulated Other Comprehensive Income (Loss) ("AOCI") were as follows: Foreign currency translation adjustments Unrecognized gain (loss) on derivative instruments Pension adjustments Total AOCI (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 AOCI — 19 — 19 Balance at December 31, 2021 22 ( 41 ) 7 ( 12 ) Other comprehensive income (loss) ( 184 ) 57 ( 25 ) ( 152 ) Taxes 26 ( 16 ) 6 16 Reclassification from AOCI — 13 — 13 Balance at September 30, 2022 $ ( 136 ) $ 13 $ ( 12 ) $ ( 135 ) Reclassifications from unrecognized loss on derivative instruments are recorded in "Interest expense, net" in the condensed consolidated statements of income. We sponsor a frozen defined benefit pension plan in the United Kingdom for former employees on an expired customer contract. On May 20, 2022, the trustee of our defined benefit pension plan (the “Plan”) invested the assets of the Plan in a bulk purchase annuity policy to fully insure the benefits payable to the members of the Plan. As the buy-in transaction insured the defined benefit obligation, we do not anticipate material future contributions. The bulk purchase annuity policy is structured to enable the Plan to move to a full buy-out, at which time the insurer would become directly responsible for all pension payments and we would be relieved of our obligations under the Plan. At this future date, a settlement loss will be recognized for an amount equal to any unamortized loss associated with the Plan recorded within AOCI and any remaining net plan assets of the Plan will be remitted to the Company. As of September 30, 2022, the unamortized loss within AOCI related to the Plan was $ 19 million and the Plan had net assets of $ 6 million. Note 8–Earnings Per Share The following table provides a reconciliation of the weighted average number of shares outstanding used to compute basic and diluted EPS for the periods presented: Three Months Ended Nine Months Ended September 30, 2022 October 1, 2021 September 30, 2022 October 1, 2021 (in millions) Basic weighted average number of shares outstanding 137 141 137 141 Dilutive common share equivalents—stock options and other stock awards 1 2 1 2 Diluted weighted average number of shares outstanding 138 143 138 143 Anti-dilutive stock-based awards are excluded from the weighted average number of shares outstanding used to compute diluted EPS. The total outstanding stock options and vesting stock awards that were anti-dilutive were 1 million for both the three and nine months ended September 30, 2022, and October 1, 2021. 18 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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. During the quarter ended April 1, 2022, we paid $ 500 million to the financial institution and received an initial delivery of 4.5 million shares. In May 2022, the financial institution elected to partially settle $ 125 million of the original $ 500 million prepayment under the ASR agreement based on the volume-weighted-average-price of $ 104.32 per share for the period February 17, 2022, to April 29, 2022, which resulted in an additional delivery of 0.1 million shares. Subsequently, the financial Institution elected to fully settle the remaining $ 375 million of the original payment under the ASR agreement based upon a volume-weighted-average-price of $ 104.23 per share for the period February 17, 2022, to May 5, 2022, and delivered an additional 0.2 million shares. The repurchases were recorded to "Additional paid-in capital" in the condensed consolidated balance sheets. All shares delivered were immediately retired. Note 9–Income Taxes For the three months ended September 30, 2022, the effective tax rate was 25.8 % compared to 20.0 % for the three months ended October 1, 2021. The increase to the effective tax rate was primarily due to a benefit from foreign operations recognized in the prior year and an increase to state income taxes and an increase in unrecognized tax benefits in the current quarter. For the nine months ended September 30, 2022, the effective tax rate was 23.2 % compared to 21.7 % for the nine months ended October 1, 2021. The increase in the effective tax rate was primarily due to a benefit from foreign operations recognized in the prior year and an increase in unrecognized tax benefits in the current year. Beginning in 2022, the Tax Cuts and Jobs Act of 2017 (“TCJA”) eliminated the option to currently deduct certain research and development costs for tax purposes and requires taxpayers to capitalize and amortize research costs over five years. Although it is possible that Congress may defer, modify, or repeal this provision, potentially with retroactive effect, we have no assurance that Congress will take any action with respect to this provision. If the 2022 effective date remains in place, based on the law as currently enacted, our initial assessment is that our income taxes payable and net deferred tax assets will each increase by approximately $ 150 million in fiscal 2022. The actual impact will depend on the amount of research and development costs the Company will incur, whether Congress modifies or repeals this provision and whether new guidance and interpretive rules are issued by the U.S. Treasury, among other factors. For the nine months ended September 30, 2022, unrecognized tax benefits increased $ 95 million with a corresponding increase to net deferred tax assets as a result of uncertain tax positions arising from certain provisions of the TCJA becoming effective. 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. During fiscal 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. 19 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) The segment information for the periods presented was as follows: Three Months Ended Nine Months Ended September 30, 2022 October 1, 2021 September 30, 2022 October 1, 2021 (in millions) Revenues: Defense Solutions $ 2,075 $ 2,009 $ 6,176 $ 5,971 Civil 874 792 2,526 2,357 Health 659 682 1,997 1,918 Total revenues $ 3,608 $ 3,483 $ 10,699 $ 10,246 Operating income (loss): Defense Solutions $ 137 $ 140 $ 409 $ 429 Civil 79 58 160 187 Health 91 130 335 339 Corporate ( 26 ) ( 23 ) ( 81 ) ( 73 ) Total operating income $ 281 $ 305 $ 823 $ 882 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 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. 20 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. Defense Contract Audit Agency As of September 30, 2022, active indirect cost audits by the Defense Contract Audit Agency remain open for fiscal 2020 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 September 30, 2022, we believe we have adequately reserved for potential adjustments from audits or reviews of contract costs. 21 Table of Contents LEIDOS HOLDINGS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Other Government Investigations and Reviews 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. In September 2022, the Company received a Federal Grand Jury Subpoena related to the criminal investigation by the U.S. Attorney’s Office for the Southern District of California, in conjunction with the U.S. Department of Justice’s Fraud Division. The subpoena requests documents relating to the conduct that is the subject of the Company’s internal investigation. The Company is in the process of responding to the subpoena. In August 2022, the Company received a Federal Grand Jury Subpoena in connection with a criminal investigation being conducted by the U.S. Department of Justice Antitrust Division (“DOJ”). The subpoena requests that the Company produce a broad range of documents related to three U.S. Government procurements associated with the Company’s Intelligence Group in 2021 and 2022. We intend to fully cooperate with the investigation, and we are conducting our own internal investigation with the assistance of outside counsel. It is not possible at this time to determine whether we will incur, or to reasonably estimate the amount of, any fines, penalties, or further liabilities in connection with the investigation pursuant to which the subpoena was issued. Commitments As of September 30, 2022, we have outstanding letters of credit of $ 44 million, principally related to performance guarantees on contracts and 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. We also have future lease commitments of $ 74 million for the use of certain aircrafts. As of September 30, 2022, the future expirations of the outstanding letters of credit, surety bonds and future lease commitments were as follows: Fiscal year ending (in millions) 2022 (remainder of year) $ 22 2023 26 2024 103 2025 22 2026 19 2027 and thereafter 26 $ 218 Note 12–Subsequent Events On October 30, 2022, we completed the previously announced acquisition of Cobham Special Mission, for a preliminary purchase price of $ 305 million Australian dollars, approximately $ 196 million United States dollars, which is subject to working capital adjustments. Additionally, we realized a loss of $ 18 million resulting from the settlement of the foreign currency forward contract intended to offset currency fluctuations related to the preliminary purchase price. 22 Table of Contents LEIDOS HOLDINGS, INC.