Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of Leidos Holdings, Inc.'s ("Leidos") financial condition, results of operations and quantitative and qualitative disclosures about business environment and trends and market risk should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties, including those described under the heading “Forward-Looking Statements.” You should also review the disclosure under Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
Unless indicated otherwise, references in this report to “we,” “us” and “our” refer collectively to Leidos and its consolidated subsidiaries.
In this section, we discuss our financial condition, changes in financial condition and results of our operations for the year ended December 30, 2022, compared to the year ended December 31, 2021. For a discussion and analysis comparing our results for the year ended December 31, 2021, to the year ended January 1, 2021, see our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 15, 2022, under Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Overview
We are a FORTUNE 500 ® technology, engineering, and science company that provides services and solutions in the defense, intelligence, civil and health markets, both domestically and internationally. We bring domain-specific capabilities and innovations to customers in each of these markets by leveraging five technical core capabilities: digital modernization, cyber operations, mission software systems, integrated systems and mission operations. Our customers include the U.S. Department of Defense ("DoD"), the U.S. Intelligence Community, the U.S. Department of Homeland Security, the Federal Aviation Administration, the Department of Veterans Affairs and many other U.S. civilian, state and local government agencies, foreign government agencies and commercial businesses. Approximately 8% of our revenues and tangible long-lived assets are generated by or owned by entities located outside of the United States. We operate in three reportable segments: Defense Solutions, Civil and Health. Additionally, we separately present the unallocable costs associated with corporate functions as Corporate.
Effective July 3, 2021, certain contracts were reassigned from the Defense Solutions reportable segment to the Civil reportable segment. Impact on the first half of fiscal 2021 segment results were determined to be immaterial and have not been recast to reflect this change.
For additional information regarding our reportable segments, see “Business” in Part I and "Note 20—Business Segments" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.
Our significant initiatives include the following:
• achieving annual revenue growth through internal collaboration and better leveraging of key differentiators across our company and the deployment of resources and investments into higher growth markets;
• increasing headcount and internal direct labor content on our contract portfolio;
• continued improvement in our back-office infrastructure and related business processes for greater effectiveness and efficiency across all business functions; and
• disciplined deployment of our cash resources and use of our capital structure to enhance shareholder value while retaining an appropriate amount of financial leverage.
Sales Trend. For fiscal 2022, revenues increased $0.7 billion, or 5%, compared to fiscal 2021, primarily due to a net increase in volumes on certain programs, program wins and a net increase in revenues related to our business acquisitions. We also received $28 million in recoveries related to stop work orders on certain programs as a result of COVID-19. The increase was partially offset by the completion of certain contracts and unfavorable exchange rate movements.
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Operating Expenses and Income Trend. For fiscal 2022, operating expenses increased by $0.7 billion, or 6%, compared to fiscal 2021. Operating margin for fiscal 2022 was 7.6% compared to 8.4% for fiscal 2021. Operating income was $1,088 million, a $64 million decrease compared to fiscal 2021. The decrease in operating income was primarily attributable to the completion of certain contracts, increase in legal fees and settlement costs and impairment charges of $37 million related to our ongoing facility rationalization efforts. The decrease in operating income was partially offset by program wins and $28 million in recoveries related to stop work orders on certain programs as a result of COVID-19.
From a macroeconomic perspective, our industry is under general competitive pressures associated with spending from our largest customer, the U.S. government, and requires a high level of cost management focus to allow us to remain competitive. Although the U.S. Presidential Administration has not indicated a desire to reduce spending in the defense and homeland security sectors, the likelihood, extent and duration of current spending levels in these areas remains unclear. We continue to review our cost structure against our anticipated sales and undertake cost management actions and efficiency initiatives where necessary.
COVID-19
For fiscal 2022, the COVID-19 pandemic did not have a material impact to revenues and operating income, other than the receipt of $28 million in recoveries, within our Health segment related to stop work orders on certain programs. The volume of global passenger air travel remains below pre-pandemic levels, which continues to impact the operations of our Security Enterprise Solutions reporting unit. The full extent of the impact of the COVID-19 pandemic on our operational and financial performance, including our ability to execute on programs in the expected timeframe, will depend on future developments, including the duration and spread of the pandemic and the distribution of vaccines, all of which are uncertain and cannot be predicted.
Business Environment and Trends
U.S. Government Markets
In fiscal 2022, we generated approximately 86% of our total revenues from contracts with the U.S. government, either as a prime contractor or a subcontractor to other contractors engaged in work for the U.S. government. Revenues under contracts with the DoD and U.S. Intelligence Community, including subcontracts under which the DoD or the U.S. Intelligence Community is the ultimate purchaser, represented approximately 44% of our total revenues for fiscal 2022. Accordingly, our business performance is affected by the overall level of U.S. government spending, especially national security, homeland security and intelligence spending, and the alignment of our service and product offerings and capabilities with current and future budget priorities of the U.S. government.
President Biden signed the $1.7 trillion GFY 2023 omnibus spending bill into law on December 29, 2022. The omnibus spending bill funds the federal government through September 30, 2023. The bill includes $772.5 billion in non-defense spending and $858.4 billion in defense spending. The bill also includes $85 billion in emergency spending not included in the discretionary amount. The new 118th Congress will begin to work on the GFY 2024 appropriations bills in the spring of 2023.
Trends in the U.S. government contracting process, including a shift towards multiple-awards contracts, in which certain contractors are preapproved using IDIQ and U.S. General Services Administration ("GSA") contract vehicles, have increased competition for U.S. government contracts, reduced backlogs by shortening periods of performance on contracts and increased pricing pressure. We expect that a majority of the business that we seek in the foreseeable future will be awarded through a competitive bidding process. For more information on these risks and uncertainties, see “Risk Factors” in Part I of this Annual Report on Form 10-K.
International Markets
Sales to customers in international markets represented approximately 8% of total revenues for fiscal 2022. Our international customers include foreign governments and their agencies. Our international business increases our exposure to international markets and the associated international regulatory, foreign currency exchange rate and geopolitical risks.
Changes in international trade policies, including higher tariffs on imported goods and materials, may increase our procurement costs of certain IT hardware used both on our contracts and for internal use. However, we expect to recover certain portions of these higher tariffs through our cost-plus contracts. While we evaluate the impact of higher tariffs, currently, we do not expect tariffs to have a significant impact to our business.
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Key Performance Measures
The primary financial performance measures we use to manage our business and monitor results of operations are revenue, operating income, cash flows from operations and diluted earnings per share. Bookings and backlog are also useful measures for management and investors to evaluate our performance and potential future revenues. In addition, we consider business performance by contract type to be useful to management and investors when evaluating our operating income and margin performance.
Results of Operations
Our results of operations for the periods presented were as follows:
Year Ended 2022 to 2021
December 30,
2022 December 31,
2021 Dollar change Percent
change
(dollars in millions)
Revenues
$ 14,396 $ 13,737 $ 659 5 %
Cost of revenues 12,312 11,723 589 5 %
Selling, general and administrative expenses 950 860 90 10 %
Credit losses (recoveries), net 1 (9) 10 (111) %
Acquisition, integration and restructuring costs
17 27 (10) (37) %
Asset impairment charges
40 4 36 NM
Equity earnings of non-consolidated subsidiaries
(12) (20) 8 (40) %
Operating income
1,088 1,152 (64) (6) %
Non-operating expense, net
(202) (185) (17) 9 %
Income before income taxes
886 967 (81) (8) %
Income tax expense
(193) (208) 15 (7) %
Net income
693 759 (66) (9) %
Less: net income attributable to non-controlling interest 8 6 2 33 %
Net income attributable to Leidos common stockholders $ 685 $ 753 $ (68) (9) %
Operating income margin
7.6 % 8.4 %
NM - Not meaningful
Segment and Corporate Results
Year Ended 2022 to 2021
Defense Solutions December 30,
2022 December 31,
2021 Dollar change Percent
change
(dollars in millions)
Revenues $ 8,244 $ 8,032 $ 212 3 %
Operating income 541 569 (28) (5) %
Operating income margin
6.6 % 7.1 %
The increase in revenues for fiscal 2022 as compared to fiscal 2021 was primarily attributable to program wins, a net increase in volumes on certain programs and a $63 million net increase in revenues related to our acquisitions made in the second and third quarters from the prior year and the Cobham Special Mission acquisition made in the current year. The increase was partially offset by the completion of certain contracts, contracts that were reassigned from Defense Solutions reportable segment to the Civil reportable segment during the third quarter of fiscal 2021 and $95 million related to unfavorable exchange rate movements.
The decrease in operating income for fiscal 2022 as compared to fiscal 2021 was primarily attributable to the completion of certain contracts, net write-downs on certain contracts, increased amortization expense of $8 million and $6 million related to unfavorable exchange rate movements. Fiscal 2022 also included impairment charges of $12 million related to our ongoing facility rationalization efforts (see "Note 10—Leases"). The decrease was partially offset by program wins and a net increase in volumes on certain programs.
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Year Ended 2022 to 2021
Civil December 30,
2022 December 31,
2021 Dollar change Percent change
(dollars in millions)
Revenues $ 3,464 $ 3,157 $ 307 10 %
Operating income 234 248 (14) (6) %
Operating income margin
6.8 % 7.9 %
The increase in revenues for fiscal 2022 as compared to fiscal 2021 was primarily attributable to program wins, a net increase in program volumes and contracts that were reassigned from Defense Solutions reportable segment to the Civil reportable segment during the third quarter of fiscal 2021. The increase was partially offset by the completion of certain contracts and $12 million of unfavorable exchange rate movements.
The decrease in operating income for fiscal 2022 as compared to fiscal 2021 was primarily attributable to a $19 million increase in legal fees and settlement costs resulting from an adverse arbitration ruling related to the 2016 acquisition of the Information Systems & Global Solutions business (“IS&GS Business”) from Lockheed Martin and impairment charges of $14 million related to our ongoing facility rationalization efforts (see "Note 10—Leases"). The decreases were partially offset by a net increase in program volumes. Operating income for fiscal 2021 included a $26 million benefit from a legal reserve adjustment related to the Mission Support Alliance joint venture (see "Note 1—Nature of Operations and Basis of Presentation").
Year Ended 2022 to 2021
Health December 30,
2022 December 31,
2021 Dollar change Percent
change
(dollars in millions)
Revenues $ 2,688 $ 2,548 $ 140 5 %
Operating income 421 442 (21) (5) %
Operating income margin
15.7 % 17.3 %
The increase in revenues for fiscal 2022 as compared to fiscal 2021 was primarily attributable to a net increase in program volumes, program wins and $28 million in recoveries related to stop work orders on certain programs as a result of COVID-19. The increase was partially offset by the completion of certain contracts.
The decrease in operating income for fiscal 2022 as compared to fiscal 2021 was primarily attributable to a net decrease in volumes on higher margin programs and the completion of certain contracts. The decrease was partially offset by $28 million in recoveries related to stop work orders on certain programs as a result of COVID-19 and program wins.
Year Ended 2022 to 2021
Corporate December 30,
2022 December 31,
2021 Dollar change Percent
change
(dollars in millions)
Operating loss $ (108) $ (107) $ (1) 1 %
The increase in operating loss for fiscal 2022 as compared to fiscal 2021 was primarily attributable to an increase in legal costs partially offset by lower acquisition and integration costs.
Equity earnings of non-consolidated subsidiaries
We have certain non-controlling ownership interests in equity method investments. For fiscal 2022 and fiscal 2021 we recorded earnings of $12 million and $20 million, respectively, from our equity method investments.
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Non-Operating Expense, Net
Non-operating expense, net increased $17 million for fiscal 2022 as compared to fiscal 2021, primarily due to higher interest expense driven by increased interest rates.
Provision for Income Taxes
Our effective tax rate was 21.8%, and 21.5% in fiscal 2022 and 2021, respectively. The effective tax rate for fiscal 2022 and 2021 were both favorably impacted primarily by federal research tax credits and excess tax benefits related to employee stock-based payment transactions.
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. Based upon our interpretation of the law as enacted, we recorded the estimated fiscal 2022 impact, resulting in increases of $130 million to both our income taxes payable and net deferred tax assets, and our fiscal 2022 unrecognized tax benefits increased by $91 million with a corresponding increase to net deferred tax assets. We expect this TCJA provision to have a similar impact to income taxes payable, unrecognized tax benefits and net deferred tax assets during fiscal 2023. 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.
Bookings and Backlog
We had net bookings of $15.4 billion and $15.5 billion during fiscal 2022 and 2021, respectively. Net bookings represent the estimated amount of revenue to be earned in the future from funded and unfunded contract awards that were received during the year, net of any adjustments to previously awarded backlog amounts. We calculate net bookings as the year’s ending backlog, plus the year’s revenues, less the prior year’s ending backlog and any impacts from foreign currency or acquisitions and divestitures.
Backlog represents the estimated amount of future revenues to be recognized under negotiated contracts. We segregate our backlog into two categories as follows:
• Funded Backlog. Funded backlog for contracts with the U.S. government represents the value on contracts for which funding is appropriated less revenues previously recognized on these contracts. Funded backlog for contracts with non-U.S. government entities and commercial customers represents the estimated value on contracts, which may cover multiple future years, under which we are obligated to perform, less revenues previously recognized on the contracts.
• Negotiated Unfunded Backlog. Negotiated unfunded backlog represents estimated amounts of revenue to be earned in the future from contracts for which funding has not been appropriated and unexercised priced contract options. Negotiated unfunded backlog does not include unexercised option periods and future potential task orders expected to be awarded under IDIQ, GSA Schedule or other master agreement contract vehicles, with the exception of certain IDIQ contracts where task orders are not competitively awarded and separately priced but instead are used as a funding mechanism, and where there is a basis for estimating future revenues and funding on future anticipated task orders.
The estimated value of our total backlog for the periods presented was as follows:
Year ended
December 30, 2022 December 31, 2021
Segment Funded Unfunded Total Funded Unfunded Total
(in millions)
Defense Solutions $ 4,442 $ 14,155 $ 18,597 $ 4,393 $ 15,274 $ 19,667
Civil 1,876 8,790 10,666 1,628 7,903 9,531
Health 2,064 4,455 6,519 1,428 3,829 5,257
Total $ 8,382 $ 27,400 $ 35,782 $ 7,449 $ 27,006 $ 34,455
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Total backlog at December 30, 2022, and December 31, 2021, included $610 million and $800 million, respectively, of backlog acquired during the year through business combinations in our Defense Solutions reportable segment.
The increase in backlog as of December 30, 2022, as compared to December 31, 2021, included an unfavorable impact of $233 million due to the movements in the British pound and Australian dollar when compared to the U.S. dollar.
Bookings and backlog fluctuate from period to period depending on our success rate in winning contracts and the timing of contract awards, renewals, modifications and cancellations, as well as foreign currency movements. Contract awards may be negatively impacted by ongoing industry-wide delays in procurement decisions and budget cuts by the U.S. government as discussed in “Business Environment and Trends” in this Annual Report on Form 10-K.
We expect to recognize a substantial portion of our funded backlog as revenues within the next 12 months. However, the U.S. government may cancel any contract at any time through a termination for the convenience of the U.S. government. In addition, certain contracts with commercial or non-U.S. government customers may include provisions that allow the customer to cancel at any time. Most of our contracts have cancellation terms that would permit us to recover all or a portion of our incurred costs and fees for work performed.
Contract Types
Our earnings and profitability may vary materially depending on changes in the proportionate amount of revenues derived from each type of contract. For a discussion of the types of contracts under which we generate revenues, see “Business—Contract Types” in Part I of this Annual Report on Form 10-K. Revenues by contract type as a percentage of our total revenues for the periods presented were as follows:
Year Ended
December 30,
2022 December 31,
2021 January 1,
2021
Cost-reimbursement and fixed-price-incentive-fee 50 % 50 % 51 %
Firm-fixed-price 38 % 37 % 36 %
Time-and-materials and fixed-price-level-of-effort 12 % 13 % 13 %
Total 100 % 100 % 100 %
Liquidity and Capital Resources
Overview of Liquidity
As of December 30, 2022, we had $516 million in cash and cash equivalents. Additionally, we have an unsecured revolving credit facility which can provide up to $750 million in additional borrowing, if required. During fiscal 2022 and 2021, there were no borrowings outstanding under the credit facilities.
At December 30, 2022 and December 31, 2021, we had outstanding debt of $4.9 billion and $5.1 billion, respectively. On May 6, 2022, we entered into a Term Loan Agreement which provided for a senior unsecured term loan facility in an aggregate principal amount of $380 million.
We have a commercial paper program in which we may issue short-term unsecured commercial paper notes not to
exceed $750 million and have maturities of up to 397 days from the date of issuance (see "Note 13—Debt"). As of December 30, 2022, we did not have any commercial paper notes outstanding.
We made principal payments on our debt of $545 million, $106 million and $731 million during fiscal 2022, 2021 and 2020, respectively. This activity included required principal payments on our term loans of $476 million, $96 million and $72 million during fiscal 2022, 2021 and 2020, respectively. During fiscal 2020, we made $4,925 million of principal repayments for outstanding debt and retired the $450 million senior notes. The notes outstanding as of December 30, 2022, contain financial covenants and customary restrictive covenants. We were in compliance with all covenants as of December 30, 2022.
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Interest on our Credit Facilities is calculated based on the London Interbank Offered Rate (“LIBOR”). On July 27, 2017, the U.K.’s Financial Conduct Authority announced that LIBOR would be discontinued or become unavailable as a reference rate by the end of 2021 and LIBOR will be fully discontinued or become unavailable as a benchmark rate by June 2023. In December 2022, the FASB issued guidance which provides relief for entities with such LIBOR denominated credit instruments so that entities may continue to account for contract modifications as a continuation of the existing contract and the continuation of the hedge accounting arrangement through December 31, 2024.
Although our Credit Facilities include mechanics to facilitate the adoption by us and our lenders of an alternative benchmark rate for use in place of LIBOR, no assurance can be made that such alternative benchmark rate will perform in a manner similar to LIBOR or result in interest rates that are at least as favorable to us as those that would have resulted had LIBOR remained in effect, which could result in an increase in our interest expense and other debt service obligations. In addition, the overall credit market may be disrupted as a result of the replacement of LIBOR or in the anticipation thereof, which could have an adverse impact on our ability to refinance, reprice, or amend our existing indebtedness or incur additional indebtedness on favorable terms.
We paid dividends of $199 million, $199 million and $196 million for fiscal 2022, 2021 and 2020, respectively.
During fiscal 2022, we sold $209 million of accounts receivable under accounts receivable purchase agreements and received proceeds of $209 million (see "Note 6—Receivables"). There were no sales of accounts receivable in the second half of fiscal 2022.
We may from time to time seek to retire or purchase our outstanding debt through cash purchases in the open market, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
Stock repurchases of Leidos common stock may be made on the open market or in privately negotiated transactions with third parties including through accelerated share repurchase ("ASR") agreements. Whether repurchases are made and the timing and actual number of shares repurchased depends on a variety of factors including price, corporate capital requirements, other market conditions and regulatory requirements. The repurchase program may be accelerated, suspended, delayed or discontinued at any time.
During fiscal 2021 and 2020, we made open market repurchases of our common stock for an aggregate purchase price of $237 million and $67 million, respectively. There were no open market share repurchases in fiscal 2022.
In fiscal 2022, we entered into an ASR with a financial institution to repurchase shares of our outstanding common stock. We paid $500 million to the financial institution and received 4.8 million shares (see "Note 16—Earnings Per Share" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K). All shares delivered were immediately retired.
During fiscal 2022, we made a $25 million payment in connection with the adverse arbitration ruling related to the 2016 acquisition of the IS&GS Business from Lockheed Martin.
Beginning in 2022, a provision in the TCJA which eliminated the option to currently deduct research and development costs for tax purposes and requires taxpayers to capitalize and amortize the costs over five years became effective. We anticipate our tax cash payments to increase by $300 million in 2023 primarily to cover both the 2022 and 2023 tax obligations related to this provision. The actual impact will depend on the amount of research and development costs the Company will incur during fiscal 2023 and whether new guidance and interpretive rules are issued by the U.S. Treasury, among other factors. We will continue to assess our liquidity needs as the tax legislation and pandemic evolve.
For the next 12 months, we anticipate that we will be able to meet our liquidity needs, including servicing our debt, through cash generated from operations, available cash balances, sales of accounts receivable and, if needed, borrowings from our revolving credit facility and commercial paper program.
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Summary of Cash Flows
The following table summarizes cash flow information for the periods presented:
Year Ended
December 30,
2022 December 31,
2021
(in millions)
Net cash provided by operating activities $ 986 $ 1,031
Net cash used in investing activities (313) (730)
Net cash used in financing activities (865) (113)
Net (decrease) increase in cash, cash equivalents and restricted cash $ (192) $ 188
Net cash provided by operating activities decreased $45 million for fiscal 2022 as compared to fiscal 2021. The decrease was primarily due to a $25 million payment in connection with the adverse arbitration ruling related to the 2016 acquisition of the IS&GS Business from Lockheed Martin and $23 million of payments for other legal and tax settlements occurred during the current year, partially offset by favorable working capital changes.
Net cash used in investing activities decreased $417 million for fiscal 2022 as compared to fiscal 2021. The decrease was primarily due to $430 million of less cash paid related to our business acquisitions in current year as compared to prior year and $15 million of proceeds received from the sale of Aviation & Missile Solutions LLC in the current year. The decrease was partially offset by $25 million of higher capital expenditures in the current year.
Net cash used in financing activities increased $752 million for fiscal 2022 as compared to fiscal 2021. The increase was primarily due to $439 million increase in principal payments of our debt, an increase of $272 million in stock repurchases primarily attributable to the accelerated share repurchase agreement and a $45 million decrease in net capital contributions received from our non-controlling interest.
Off-Balance Sheet Arrangements
We have outstanding performance guarantees and cross-indemnity agreements in connection with certain aspects of our business. We have letters of credit outstanding principally related to performance guarantees on contracts and surety bonds outstanding principally related to performance and subcontractor payment bonds. We also have future lease commitments for the use of certain aircraft as described in "Note 21—Commitments and Contingencies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K. These arrangements have not had, and management does not believe it is likely that they will in the future have, a material effect on our liquidity, capital resources, operations or financial condition.
Contractual Obligations
Our future contractual obligations are related to debt, finance and operating leases, long-term liabilities under deferred compensation arrangements, purchase obligations for long-term purchases and service agreements and other liabilities. For more information, see "Note 10—Leases", "Note 13—Debt", “Note 19—Retirement Plans” and "Note 21—Commitments and Contingencies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.
We have interest payments related to our outstanding debt and finance leases. As of December 30, 2022, future scheduled interest payments on our outstanding debt and finance leases were $195 million, expected to be paid in fiscal 2023 and $946 million expected to be paid thereafter.
As of December 30, 2022, future payments on our deferred compensation arrangements and purchase obligations for long-term purchases and service agreements were $36 million, expected to be paid in fiscal 2023, and $120 million expected to be paid thereafter. Our future payments do not include $92 million of income tax liabilities as a result of uncertain tax positions arising from certain provisions of the TCJA becoming effective in 2022, and the timing of such payments, if any, cannot be reasonably estimated. For additional information, see "Note 18—Income Taxes" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.
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Guarantors and Issuers of Guaranteed Securities
Leidos Holdings, Inc. ( “ Guarantor ” ) has fully and unconditionally guaranteed the debt securities of its subsidiary, Leidos, Inc. ( “ Issuer ” ), that were issued pursuant to transactions that were registered under the Securities Act of 1933, as amended (collectively, the “Registered Notes”). The following is a list of the Registered Notes guaranteed by Leidos Holdings, Inc.
Senior unsecured Registered Notes:
$500 million 2.950% notes, due May 2023
$500 million 3.625% notes, due May 2025
$750 million 4.375% notes, due May 2030
$1,000 million 2.300% notes, due February 2031
Leidos Holdings, Inc. has also fully and unconditionally guaranteed debt securities of Leidos, Inc. that were issued pursuant to transactions that were not registered under the Securities Act of 1933, as amended. The following is a list of unregistered debt securities guaranteed by Leidos Holdings, Inc.
Senior unsecured unregistered debt securities issued by Leidos, Inc.:
$250 million 7.125% notes, due July 2032
$300 million 5.500% notes, due July 2033
Additionally, Leidos, Inc. has fully and unconditionally guaranteed debt securities of Leidos Holding, Inc. that were issued pursuant to transactions that were not registered under the Securities Act of 1933, as amended. The following is a list of unregistered debt securities guaranteed by Leidos, Inc.
Senior unsecured unregistered debt securities issued by Leidos Holdings, Inc.:
$300 million 5.950% notes, due December 2040
The following summarized financial information includes the assets, liabilities and results of operations for the Guarantor and Issuer of the Registered Notes described above. Intercompany balances and transactions between the Issuer and Guarantor have been eliminated from the financial information below. Investments in the consolidated subsidiaries of the Issuer and Guarantor that do not guarantee the senior unsecured notes have been excluded from the financial information. Intercompany payables represent amounts due to non-guarantor subsidiaries of the Issuer.
Balance Sheet Information for the Guarantor and Issuer of Registered Notes
December 30,
2022
(in millions)
Total current assets $ 2,115
Goodwill 5,810
Other long-term assets 1,188
Total assets $ 9,113
Total current liabilities $ 2,922
Long-term debt, net of current portion 3,925
Intercompany payables 1,695
Other long-term liabilities 699
Total liabilities $ 9,241
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Statement of Income Information for the Guarantor and Issuer of Registered Notes
December 30,
2022
(in millions)
Revenues, net $ 9,808
Operating income 698
Net income 250
Commitments and Contingencies
We are subject to a number of reviews, investigations, claims, lawsuits, other uncertainties and future obligations related to our business. For a discussion of these items, see "Note 10—Leases" and "Note 21—Commitments and Contingencies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.
Critical Accounting Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingencies at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Management evaluates these estimates and assumptions on an ongoing basis. Our estimates and assumptions have been prepared by management on the basis of the most current and best available information. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from these estimates under different assumptions and conditions.
We have identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our results of operations or financial condition.
• Revenue Recognition
• Goodwill and Intangible Assets
Revenue Recognition
We perform work under various types of contracts, which include firm-fixed-price ("FFP"), time-and-materials ("T&M"), fixed-price-level-of-effort ("FP-LOE"), cost-plus-fixed-fee ("CPFF"), cost-plus-award-fee, cost-plus-incentive-fee and fixed-price-incentive-fee contracts. Some of these contracts require us to use estimates of the revenue and cost associated with the design, manufacture and delivery of our products and services for the purposes of recognizing revenue.
We also evaluate whether two or more contracts should be combined and accounted for as a single contract, including the task orders issued under an IDIQ award. In addition, we assess contract modifications to determine whether changes to existing contracts should be accounted for as part of the original contract or as a separate contract. Some of our cost-plus and fixed-price contracts contain award fees, incentive fees or other provisions that may either increase or decrease the transaction price. These variable amounts generally are awarded upon achievement of certain performance metrics, program milestones or cost targets and can be based upon customer discretion. We estimate variable consideration at the most probable amount that we expect to be entitled to, based on the assessment of the contractual variable fee criteria, complexity of work and related risks, extent of customer discretion, amount of variable consideration received historically and the potential of significant reversal of revenue.
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On FFP contracts requiring system integration and cost-plus contracts with variable consideration, revenue is recognized over time generally using a method that measures the extent of progress towards completion of a performance obligation, principally using a cost-input method (referred to as the cost-to-cost method). Under the cost-to-cost method, revenue is recognized based on the proportion of total costs incurred to estimated total costs-at-completion ("EAC"). A performance obligation's EAC includes all direct costs such as materials, labor, subcontract costs, overhead and a ratable portion of general and administrative costs. In addition, an EAC of a performance obligation includes future losses estimated to be incurred on onerous contracts, as and when known.
For the impacts of changes in estimates on our contracts, (see "Note 3—Summary of Significant Accounting Policies").
Goodwill and Intangible Assets
Goodwill represents the excess of the fair value of consideration transferred, plus the fair value of any non-controlling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. We recognize purchased intangible assets in connection with our business acquisitions at fair value on the acquisition date.
Goodwill is not amortized, but instead is tested annually, at the beginning of the fourth quarter, for impairment at the reporting unit level and may be tested more frequently if events or circumstances indicate that the carrying value may not be recoverable. Intangible assets with indefinite lives are not amortized but are assessed for impairment at the beginning of the fourth quarter and whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
Goodwill and intangible assets, net, collectively represent 59% and 60% of our total assets as of December 30, 2022 and December 31, 2021, respectively.
We may perform qualitative or quantitative analysis to test for impairment. Qualitative factors may include macroeconomic, industry and market considerations, overall financial performance, industry, legal and other relevant events and factors affecting the reporting unit.
For quantitative analysis, we use discounted cash flow models and market multiple analyses in order to estimate reporting unit fair values. Discounted cash flow analyses rely on significant judgement and assumptions about expected future cash flows, weighted-average cost of capital, discount rates, expected long-term growth rates and operating margins. These assumptions are based on estimates of future sales and earnings after considering such factors as general market conditions, customer budgets, existing firm and future orders, changes in working capital, long term business plans and recent operating performance. Market multiple analyses incorporate significant judgments and assumptions related to the selection of guideline public companies, our forecast earnings before interest, taxes, depreciation and amortization (“EBITDA”), forecast EBITDA of guideline public companies and control premium estimates.
We performed our annual test for impairment as of October 1, 2022, which resulted in no impairments being identified. However, through this analysis we determined that our Security Enterprise Solutions reporting unit within the Civil reportable segment, which holds goodwill in the amount of $899 million as of December 30, 2022, was at risk of future impairment. The estimated fair value of the Security Enterprise Solutions reporting unit exceeded the carrying value by approximately 13%. Operations of the reporting unit rely heavily on the sales and servicing of security and detection products, which have been negatively impacted by COVID-19. The forecasts utilized to estimate the fair value of the Security Enterprise Solutions reporting unit assume continued global operations in all of our existing markets and a gradual improvement in the global aviation security product and related service sales, reaching pre-COVID-19 levels by fiscal 2025. The fair value of the reporting unit is also negatively impacted by rising interest rate factored into cost of capital. 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 or intangible assets at a future date.
Recently Adopted and Issued Accounting Pronouncements
For a discussion of these items, see "Note 2—Accounting Standards" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K.
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