Leidos Holdings, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of Leidos Holdings, Inc.'s ("Leidos") financial condition, results of operations and quantitative and qualitative disclosures about business environment and trends and market risk should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties, including those described under the heading “Forward-Looking Statements.” You should also review the disclosure under Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Unless indicated otherwise, references in this report to “we,” “us” and “our” refer collectively to Leidos and its consolidated subsidiaries. In this section, we discuss our financial condition, changes in financial condition and results of our operations for the year ended December 29, 2023, compared to the year ended December 30, 2022. For a discussion and analysis comparing our results for the year ended December 30, 2022, to the year ended December 31, 2021, see our Annual Report on Form 10-K for the year ended December 30, 2022, filed with the SEC on February 14, 2023, under Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Overview Leidos, recognized as a member of the Fortune 500®, is a dynamic innovation company that is at the forefront of addressing the world’s most challenging issues in national security and health sectors. With a global workforce of approximately 47,000, Leidos is committed to developing smarter technology solutions, particularly for customers in highly regulated industries. 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, National Aeronautics and Space Administration ("NASA") and many other U.S. civilian, state and local government agencies, foreign government agencies and commercial businesses. Approximately 9% of our revenues are generated by entities located outside of the United States. Our business has been aligned in three reportable segments: Defense Solutions, Civil and Health. Additionally, we separately present the unallocable costs associated with corporate functions as Corporate. 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 profitable growth markets; • 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 2023, revenues increased $1.0 billion, or 7%, compared to fiscal 2022, primarily due to program wins, a net increase in volumes on certain programs and a net increase in revenues attributable to our business acquisitions. The increase was partially offset by the completion of certain contracts. Leidos Holdings, Inc. Annual Report - 52 Table of Contents PART II Operating Expenses and Income Trend. For fiscal 2023, operating expenses increased by $1.5 billion, or 11%, compared to fiscal 2022. Operating margin for fiscal 2023 was 4.0% compared to 7.6% for fiscal 2022. Operating income was $621 million, a $467 million decrease compared to fiscal 2022. The decrease was primarily attributable to a net increase in impairment charges of $647 million mainly in our SES reporting unit (see "Note 8—Goodwill and Intangible Assets" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K). The decrease was partially offset by program wins, a net increase in volumes on certain programs and lower amortization expenses. 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. Business Environment and Trends U.S. Government Markets We generated approximately 87% of our total revenues from contracts with the U.S. government in fiscal 2023, as compared to 86% of our total revenues from contracts with the U.S. government in fiscal 2022, 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 49% and 44% of our total revenues for fiscal 2023 and 2022, respectively. 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. On January 18, 2024, Congress passed a third continuing resolution (“CR”) to avoid a federal government shutdown. The resolution is structured in two tiers with the first deadline being March 1, 2024, for Military Construction-VA, Agriculture, Energy-Water, and Transportation-HUD funding bills. The eight remaining bills have a March 8, 2024, deadline. The CR gives lawmakers extra time to consider the appropriations bills for government fiscal year (“GFY”) 2024. Failure to pass the appropriations bills or another CR by March 1 and March 8, 2024, will result in a partial or complete federal government shutdown. 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 9% of total revenues for fiscal 2023, as compared to 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. 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. Leidos Holdings, Inc. Annual Report - 53 Table of Contents PART II Results of Operations Our results of operations for the periods presented were as follows: Year Ended 2023 to 2022 December 29, 2023 December 30, 2022 Dollar change Percent change (dollars in millions) Revenues $ 15,438 $ 14,396 $ 1,042 7 % Cost of revenues 13,194 12,312 882 7 % Selling, general and administrative expenses 942 951 (9) (1) % Acquisition, integration and restructuring costs 24 17 7 41 % Goodwill impairment charges 596 — 596 NM Asset impairment charges 91 40 51 128 % Equity earnings of non-consolidated subsidiaries (30) (12) (18) 150 % Operating income 621 1,088 (467) (43) % Non-operating expense, net (218) (202) (16) 8 % Income before income taxes 403 886 (483) (55) % Income tax expense (195) (193) (2) 1 % Net income 208 693 (485) (70) % Less: net income attributable to non-controlling interest 9 8 1 13 % Net income attributable to Leidos common stockholders $ 199 $ 685 $ (486) (71) % Operating margin 4.0 % 7.6 % NM - Not meaningful Segment and Corporate Results Year Ended 2023 to 2022 Defense Solutions December 29, 2023 December 30, 2022 Dollar change Percent change (dollars in millions) Revenues $ 8,732 $ 8,244 $ 488 6 % Operating income 636 541 95 18 % Operating margin 7.3 % 6.6 % The increase in revenues for fiscal 2023 as compared to fiscal 2022 was primarily attributable to program wins, a net increase in volumes on certain programs and a $94 million net increase in revenues related to our Cobham Special Mission acquisition made in the last quarter of fiscal 2022. The increase was partially offset by the completion of certain contracts and an unfavorable net impact from exchange rate movements. The increase in operating income for fiscal 2023 as compared to fiscal 2022 was primarily attributable to program wins, a net increase in volumes, improved cost control and net write-ups on certain contracts, partially offset by the completion of certain contracts. Leidos Holdings, Inc. Annual Report - 54 Table of Contents PART II Year Ended 2023 to 2022 Civil December 29, 2023 December 30, 2022 Dollar change Percent change (dollars in millions) Revenues $ 3,664 $ 3,464 $ 200 6 % Operating (loss) income (413) 234 (647) (276) % Operating margin (11.3) % 6.8 % The increase in revenues for fiscal 2023 as compared to fiscal 2022 was primarily attributable to a net increase in volumes on certain programs and program wins. The decrease in operating income for fiscal 2023 as compared to fiscal 2022 was primarily attributable to a net increase in impairment charges of $665 million, restructuring charges of $10 million and higher margin offerings on certain programs in the prior year. The decrease was partially offset by $19 million in legal reserves and fees resulting from an adverse arbitration ruling in the prior year. Year Ended 2023 to 2022 Health December 29, 2023 December 30, 2022 Dollar change Percent change (dollars in millions) Revenues $ 3,042 $ 2,688 $ 354 13 % Operating income 528 421 107 25 % Operating margin 17.4 % 15.7 % The increase in revenues for fiscal 2023 as compared to fiscal 2022 was primarily attributable to a net increase in volumes on certain programs, program wins and increased earnings from incentive awards. The increase was partially offset by completion of certain contracts and a net decrease in the recovery of expenditures in the medical examination business. The increase in operating income for fiscal 2023 as compared to fiscal 2022 was primarily attributable to increased earnings from incentive awards and a net increase in volumes on certain programs, partially offset by a net decrease in the recovery of expenditures in the medical examination business. Year Ended 2023 to 2022 Corporate December 29, 2023 December 30, 2022 Dollar change Percent change (dollars in millions) Operating loss $ (130) $ (108) $ (22) 20 % The increase in operating loss for fiscal 2023 as compared to fiscal 2022 was primarily attributable to higher legal costs, increased expenses in integration and restructuring activities, partially offset by the impact of foreign payroll tax reserves. Non-Operating Expense, Net Non-operating expense, net increased by $16 million for fiscal 2023 as compared to fiscal 2022, primarily due to a net increase in interest expense driven by higher interest rates and refinancing activities. Provision for Income Taxes Our effective tax rate was 48.4% and 21.8% in fiscal 2023 and 2022, respectively. The effective tax rate for fiscal 2023 was unfavorably impacted primarily by non tax deductible goodwill impairments. The effective tax rate for fiscal 2022 was favorably impacted primarily by federal research tax credits and excess tax benefits related to employee stock-based payment transactions. Leidos Holdings, Inc. Annual Report - 55 Table of Contents PART II 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. 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. In December 2021, the Organization for Economic Cooperation and Development (“OECD”) enacted model rules for a new 15% global minimum tax framework (“Pillar Two”). Many governments around the world have enacted or are in the process of enacting Pillar Two legislation. We are evaluating the potential impact of the rules but currently do not expect them to have a material impact. Bookings and Backlog We had net bookings of $16.5 billion and $15.4 billion during fiscal 2023 and 2022, 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 29, 2023 December 30, 2022 Segment Funded Unfunded Total Funded Unfunded Total (in millions) Defense Solutions $ 4,541 $ 14,783 $ 19,324 $ 4,442 $ 14,155 $ 18,597 Civil 2,182 9,475 11,657 1,876 8,790 10,666 Health 2,073 3,908 5,981 2,064 4,455 6,519 Total $ 8,796 $ 28,166 $ 36,962 $ 8,382 $ 27,400 $ 35,782 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. Leidos Holdings, Inc. Annual Report - 56 Table of Contents PART II 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 29, 2023 December 30, 2022 December 31, 2021 Cost-reimbursement and fixed-price-incentive-fee 48 % 50 % 50 % Firm-fixed-price 39 % 38 % 37 % Time-and-materials and fixed-price-level-of-effort 13 % 12 % 13 % Total 100 % 100 % 100 % Liquidity and Capital Resources Overview of Liquidity As of December 29, 2023, we had $777 million in cash and cash equivalents. In March 2023, we entered into a senior unsecured revolving credit facility which can provide up to $1.0 billion in additional borrowing, if required. This new credit facility replaced the previous senior unsecured revolving credit facility. As of December 29, 2023, and December 30, 2022, there were no borrowings outstanding under any revolving credit facility. At December 29, 2023, and December 30, 2022, we had outstanding debt of $4.7 billion and $4.9 billion, respectively. In February 2023, we issued and sold $750 million 5.75% fixed-rate senior notes. The annual interest rate is payable on a semi-annual basis. In March 2023, we entered into a Credit Agreement with certain financial institutions, which provided for a senior unsecured term loan facility in an aggregate principal amount of $1.0 billion (the “Term Loan Facility”). The proceeds of the Term Loan Facility and cash on hand were used to repay in full all indebtedness, terminate all commitments and discharge all guarantees existing in connection with a predecessor $1.9 billion senior unsecured term loan facility and a senior unsecured revolving facility. As of December 29, 2023, borrowings under our Credit Agreement were based on a Term Secured Overnight Financing Rate (“SOFR”) with a 0.10% Term SOFR adjustment and an applicable margin range from 1.00% to 1.50%. At December 29, 2023, the applicable margin for SOFR-denominated borrowings was 1.25%. We have a commercial paper program in which we may issue short-term unsecured commercial paper notes ("Commercial Paper Notes") that have maturities of up to 397 days from the date of issuance (see "Note 13—Debt"). On May 26, 2023, we increased the size of the commercial paper program by $250 million, or not to exceed $1.0 billion. As of December 29, 2023, and December 30, 2022, we did not have any commercial paper notes outstanding. We made principal payments, excluding the impacts of our Commercial Paper Notes, on our debt of $2,045 million, $545 million and $106 million during fiscal 2023, 2022 and 2021, respectively. The activity for fiscal 2023 included a $1,210 million payment to discharge the existing Term Loan Facility, a $498 million payment to discharge the $500 million 2.95% notes, due May 2023, and a principal repayment of $320 million to discharge the 364-day term loan credit agreement. Our credit facility, term loan facility, commercial paper notes and notes outstanding as of December 29, 2023, contain financial covenants and customary restrictive covenants. We were in compliance with all covenants as of December 29, 2023. We paid dividends of $201 million for fiscal 2023 and $199 million for both fiscal 2022 and 2021. Leidos Holdings, Inc. Annual Report - 57 Table of Contents PART II We may from time to time seek to retire or purchase our outstanding debt through cash purchases in the open market, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material. Stock repurchases of Leidos common stock may be made on the open market or in privately negotiated transactions with third parties including through accelerated share repurchase ("ASR") agreements. Whether repurchases are made and the timing and actual number of shares repurchased depends on a variety of factors including price, corporate capital requirements, other market conditions and regulatory requirements. The repurchase program may be accelerated, suspended, delayed or discontinued at any time. During fiscal 2023 and 2021, we made open market repurchases of our common stock for an aggregate purchase price of $225 million and $237 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. Beginning in 2022, a provision in the TCJA which eliminated the option to currently deduct research and development costs for tax purposes, requiring taxpayers to capitalize and amortize the costs over five years became effective. Our tax cash payments increased by approximately $260 million in fiscal 2023, primarily to cover both the fiscal 2022 and 2023 tax obligations related to this provision and we anticipate an increase of approximately $60 million in the fiscal year ending January 3, 2025, ("fiscal 2024"). The actual impact will depend on the amount of research and development costs the Company incurs, 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 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, borrowings from our commercial paper program and, if needed, sales of accounts receivable and borrowings from our revolving credit facility. Summary of Cash Flows The following table summarizes cash flow information for the periods presented: Year Ended December 29, 2023 December 30, 2022 (in millions) Net cash provided by operating activities (1) $ 1,165 $ 992 Net cash used in investing activities (211) (313) Net cash used in financing activities (715) (865) (1) Net cash provided by operating activities during the year ended December 30, 2022, was recast to present the effect of foreign exchange rate changes on cash, cash equivalents and restricted cash as a separate line in the consolidated statements of cash flows. Net cash provided by operating activities increased $173 million for fiscal 2023 as compared to fiscal 2022. The increase was primarily due to faster collections on receivables and favorable timing of customer advance payments, partially offset by higher tax payments of $260 million mainly in connection with the TCJA provision. Net cash used in investing activities decreased $102 million for fiscal 2023 as compared to fiscal 2022. The decrease was primarily due to $190 million of cash paid in connection with our Cobham Special Mission acquisition from the prior year, partially offset with higher capital expenditures of $78 million in the current year. Net cash used in financing activities decreased $150 million for fiscal 2023 as compared to fiscal 2022. The decrease was primarily due a net decrease of $296 million in stock repurchases driven by the accelerated share repurchase agreement in the prior year and an increase of $1.4 billion in proceeds received from the issuance of debt in the current year, partially offset by an increase of $1.5 billion in payments of debt. Leidos Holdings, Inc. Annual Report - 58 Table of Contents PART II 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 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 29, 2023, future scheduled interest payments on our outstanding debt and finance leases were $242 million, expected to be paid in fiscal 2024 and $1.3 billion expected to be paid thereafter. As of December 29, 2023, future payments on our deferred compensation arrangements and purchase obligations for long-term purchases and service agreements were $51 million, expected to be paid in fiscal 2024, and $157 million expected to be paid thereafter. Our future payments do not include $114 million of income tax liabilities, primarily as a result of uncertain tax positions, 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. Leidos Holdings, Inc. Annual Report - 59 Table of Contents PART II 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 3.625% notes, due May 2025 $750 million 4.375% notes, due May 2030 $1,000 million 2.300% notes, due February 2031 $750 million 5.750% notes, due March 2033 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 29, 2023 (in millions) Total current assets $ 2,464 Goodwill 5,517 Other long-term assets 1,241 Total assets $ 9,222 Total current liabilities $ 1,983 Long-term debt, net of current portion 4,663 Intercompany payables 2,523 Other long-term liabilities 599 Total liabilities $ 9,768 Leidos Holdings, Inc. Annual Report - 60 Table of Contents PART II Statement of Operations Information for the Guarantor and Issuer of Registered Notes December 29, 2023 (in millions) Revenues, net $ 10,382 Operating income 538 Net income attributable to Leidos common stockholders 8 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 FFP, T&M, FP-LOE, cost-plus-fixed-fee, cost-plus-award-fee, cost-plus-incentive-fee and fixed-price-incentive-fee contracts. On FFP contracts requiring system integration and cost-plus contracts with variable consideration, revenue is generally recognized over time 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"), which require us to use estimates of the revenue and cost associated with the design, manufacture and delivery of our offerings and services. 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. If the estimated cost of a performance obligation whose associated revenue is recognized using the cost-to-cost method exceeds the estimated transaction price, the entire amount of the loss is recognized in operations in the period the loss is known. 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. We allocate the transaction price of a contract to its performance obligations proportionately based upon the individual selling prices. The standalone selling price of the performance obligations is generally based on an expected cost-plus margin approach. For certain product sales, prices from other standalone sales are used. Substantially all of our contracts do not contain a significant financing component, which would require an adjustment to the transaction price of the contract. Leidos Holdings, Inc. Annual Report - 61 Table of Contents PART II For the impacts of changes in estimates on our contracts, see "Note 3—Summary of Significant Accounting Policies" of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K. 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 53% and 59% of our total assets as of December 29, 2023, and December 30, 2022, respectively. We may perform qualitative or quantitative analysis to test for impairment. Qualitative factors include macroeconomic, industry and market considerations, overall financial performance, industry, legal and other relevant events and factors affecting the reporting unit. Our quantitative analysis utilizes discounted cash flow models and market multiple valuation methods to estimate reporting unit fair values. Discounted cash flow analyses rely on significant judgment 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. Operations of the Security Enterprise Solutions ("SES") reporting unit rely heavily on the sales and servicing of security and detection products, which continue to be negatively impacted due to delays in airline travel infrastructure projects as customer budgets recover from the pandemic. During the third quarter of fiscal 2023, the SES reporting unit refined its portfolio and made strategic business decisions to exit certain product offerings, as well as cease operations in certain countries in order to align the operations of the reporting unit with its strategic business plan. These decisions, along with the delays in airline travel infrastructure projects and higher than anticipated servicing costs, contributed to a significant reduction in the reporting unit’s forecasted revenue and cash flows. As a result, we conducted an interim quantitative goodwill impairment analysis and our estimates led us to determine that the carrying value of the SES reporting unit exceeded its estimated fair value (see “Note 11—Fair Value Measurements” of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K). Accordingly, we recognized a non-cash goodwill impairment charge of $596 million for fiscal 2023 (see “Note 8—Goodwill and Intangible Assets” of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K). We performed our annual test for impairment as of September 30, 2023, which resulted in no further impairments being identified. Our strategic decisions regarding SES’ product offerings and operating regions caused certain technology and In-process research and development intangible assets to be abandoned and the carrying values of certain program intangible assets to become unrecoverable. As a result, we recognized intangible asset impairment charges of $79 million for fiscal 2023 (see “Note 8—Goodwill and Intangible Assets” of the notes to the consolidated financial statements contained within this Annual Report on Form 10-K). Leidos Holdings, Inc. Annual Report - 62 Table of Contents PART II 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. 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.