Leidos Holdings, Inc. 10-Q

Item 2. 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 discussion about business environment and trends should be read in conjunction with Leidos' condensed consolidated financial statements and related notes. The following discussion contains forward-looking statements, including statements regarding our intent, belief or current expectations with respect to, among other things, trends affecting our financial condition or results of operations, backlog, our industry, the impact of our merger and acquisition activity, government budgets and spending, our business contingency plans, interest rates and uncertainties in tax due to new tax legislation or other regulatory developments. In some cases, forward-looking statements can be identified by words such as “will,” “expect,” “estimate,” “plan,” “potential,” “continue” or similar expressions. Such statements are not guarantees of future performance and involve risks and uncertainties and actual results may differ materially from those in the forward-looking statements as a result of various factors. Some of these factors include, but are not limited to, the risk factors set forth in our Annual Report on Form 10-K, as updated by the risk factor in this report under Part II, Item 1A. "Risk Factors" and as may be further updated in subsequent filings with the U.S. Securities and Exchange Commission. Due to such uncertainties and risks, you are cautioned not to place undue reliance on such forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to update these factors or to publicly announce the results of any changes to our forward-looking statements due to future events or developments. Unless indicated otherwise, references in this report to "we," "us" and "our" refer collectively to Leidos and its consolidated subsidiaries. Overview Leidos, 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 capability and cross-market 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 and many other U.S. civilian, state and local government agencies, foreign government agencies and commercial businesses. Beginning in fiscal 2024, we realigned our business and operate in four reportable segments that are focused on specific, defined capability sets we bring to our customers. As a result of this change, prior year segment results and disclosures have been recast to reflect the current reportable segment structure. We now operate in the following reportable segments: National Security and Digital, Health & Civil, Commercial & International and Defense Systems. We also separately present the unallocable costs associated with corporate functions as Corporate (see "Note 10–Business Segments"). Business Environment and Trends U.S. Government Markets During both of the three months ended March 29, 2024, and March 31, 2023, we generated approximately 87% of total revenues from contracts with the U.S. government. Accordingly, our business performance is affected by the overall level of U.S. government spending, especially on national security, homeland security and intelligence, and the alignment of our service and product offerings and capabilities with current and future budget priorities of the U.S. government. Congress avoided a government shutdown by passing two appropriations packages. The first package passed on March 8, 2024, included Agriculture-FDA, Energy-Water, Military Construction-VA, Transportation-HUD, Interior-Environment and Commerce-Justice-Science funding bills. The second package passed on March 23, 2024, included Defense, Financial Services, Homeland Security, Labor-HHS-Education, Legislative Branch, and State-Foreign Operations funding bills. In addition, the $7.3 trillion President’s budget was released on March 11, 2024, which is a 4.7% increase over the current budget and seeks to boost defense spending by 1% and non-defense discretionary spending by 2.4%. The spending complies with caps that House Republicans pushed in last year's Fiscal Responsibility Act in exchange for raising the debt limit. Congress will now focus on the government fiscal year ("GFY") 2025 appropriations bills before the GFY 2024 appropriations bills expire at the end of September 2024. 20 Table of Contents LEIDOS HOLDINGS, INC. International Markets Sales to customers in international markets represented approximately 8% of total revenues for both of the three months ended March 29, 2024, and March 31, 2023. Our international customers include foreign governments and their agencies. Our international business increases our exposure to international markets and the associated international regulatory and geopolitical risks. Changes in international trade policies, including higher tariffs on imported goods and materials, may increase the procurement cost of certain IT hardware used both on our contracts and internally. However, we expect to recover certain portions of these higher tariffs through our cost-plus contracts. We are currently evaluating the impact of higher tariffs, and do not expect the tariffs to have a significant impact to our business. Results of Operations The following table summarizes our condensed consolidated results of operations for the periods presented: Three Months Ended March 29, 2024 March 31, 2023 Dollar change Percent change (dollars in millions) Revenues $ 3,975 $ 3,699 $ 276 7.5 % Operating income 415 265 150 56.6 % Non-operating expense, net (47) (58) 11 (19.0) % Income before income taxes 368 207 161 77.8 % Income tax expense (85) (43) (42) 97.7 % Net income $ 283 $ 164 $ 119 72.6 % Net income attributable to Leidos common stockholders $ 284 $ 162 $ 122 75.3 % Operating margin 10.4 % 7.2 % Segment and Corporate Results Three Months Ended National Security and Digital March 29, 2024 March 31, 2023 Dollar change Percent change (dollars in millions) Revenues $ 1,793 $ 1,757 $ 36 2.0 % Operating income 175 145 30 20.7 % Operating margin 9.8 % 8.3 % The increase in revenues for the three months ended March 29, 2024, as compared to the three months ended March 31, 2023, was primarily attributable to a net increase in volumes on certain programs and program wins, partially offset by the completion of certain contracts. The increase in operating income for the three months ended March 29, 2024, as compared to the three months ended March 31, 2023, was primarily attributable to a net increase in volumes on certain programs, partially offset by the completion of certain contracts. Three Months Ended Health & Civil March 29, 2024 March 31, 2023 Dollar change Percent change (dollars in millions) Revenues $ 1,199 $ 1,008 $ 191 18.9 % Operating income 222 113 109 96.5 % Operating margin 18.5 % 11.2 % The increase in revenues for the three months ended March 29, 2024, as compared to the three months ended March 31, 2023, was primarily attributable to higher volumes in the managed health services business, ramp up on certain programs and program wins. 21 Table of Contents LEIDOS HOLDINGS, INC. The increase in operating income for the three months ended March 29, 2024, as compared to the three months ended March 31, 2023, was primarily driven by a net increase in volumes and favorable business mix in the managed health services business. Three Months Ended Commercial & International March 29, 2024 March 31, 2023 Dollar change Percent change (dollars in millions) Revenues $ 509 $ 489 $ 20 4.1 % Operating income 34 13 21 161.5 % Operating margin 6.7 % 2.7 % The increase in revenues and operating income for the three months ended March 29, 2024, as compared to the three months ended March 31, 2023, was primarily attributable to a net increase in volumes driven by commercial product mix and improved cost control, partially offset by the completion of certain contracts. Three Months Ended Defense Systems March 29, 2024 March 31, 2023 Dollar change Percent change (dollars in millions) Revenues $ 474 $ 445 $ 29 6.5 % Operating income 21 23 (2) (8.7) % Operating margin 4.4 % 5.2 % The increase in revenues for the three months ended March 29, 2024, as compared to the three months ended March 31, 2023, was primarily attributable to an increase in volumes on certain programs and program wins. The decrease in operating income for the three months ended March 29, 2024, as compared to the three months ended March 31, 2023, was primarily attributable to changes in program mix, partially offset by program wins. Three Months Ended Corporate March 29, 2024 March 31, 2023 Dollar change Percent change (dollars in millions) Operating loss $ (37) $ (29) $ (8) 27.6 % The increase in operating loss for the three months ended March 29, 2024, as compared to the three months ended March 31, 2023, was primarily attributable to increased general and administrative expenses. Non-Operating Expense, net Non-operating expense, net for the three months ended March 29, 2024, was $47 million as compared to $58 million for the three months ended March 31, 2023. The decrease was primarily due to increased interest income on higher cash balances and favorable exchange rate movements. Provision for Income Taxes For the three months ended March 29, 2024, our effective tax rate was 23.1% compared to 20.8% for the three months ended March 31, 2023. The increase to the effective tax rate was primarily due to an increase in unrecognized tax benefits and a reduced benefit in federal research tax credits, partially offset by an increase in excess tax benefits related to employee stock-based payment transactions. In December 2021, the Organization for Economic Cooperation and Development 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. The Pillar Two legislation is effective for certain jurisdictions beginning in fiscal 2024. We will continue to evaluate the potential impact of the rules as additional legislation gets enacted but currently do not expect them to have a material impact. 22 Table of Contents LEIDOS HOLDINGS, INC. Bookings and Backlog We recorded net bookings worth an estimated $3.7 billion during the three months ended March 29, 2024, as compared to $3.0 billion for the three months ended March 31, 2023. The estimated value of our total backlog was as follows: March 29, 2024 March 31, 2023 Segment Funded Unfunded Total Funded Unfunded Total (in millions) National Security and Digital $ 2,411 $ 15,144 $ 17,555 $ 2,984 $ 13,030 $ 16,014 Health & Civil 1,953 8,767 10,720 1,740 9,572 11,312 Commercial & International 2,465 2,071 4,536 2,537 1,317 3,854 Defense Systems 1,136 2,624 3,760 1,042 2,864 3,906 Total $ 7,965 $ 28,606 $ 36,571 $ 8,303 $ 26,783 $ 35,086 Backlog represents the estimated amount of future revenues to be recognized under negotiated contracts, both funded and unfunded. Backlog 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. Backlog estimates are subject to change and may be affected by factors including modifications of contracts and foreign currency movements. Liquidity and Capital Resources Overview As of March 29, 2024, we had $633 million in cash and cash equivalents. We have a senior unsecured revolving credit facility which can provide up to $1 billion in additional borrowing, if required. As of March 29, 2024, and December 29, 2023, there were no borrowings outstanding under the revolving credit facility. We had outstanding debt of $4.7 billion at both March 29, 2024, and December 29, 2023. We have a commercial paper program in which we may issue short-term unsecured commercial paper notes ("Commercial Paper Notes") and have maturities of up to 397 days from the date of issuance. As of March 29, 2024, and December 29, 2023, 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 $4 million and $1,711 million during the three months ended March 29, 2024, and March 31, 2023, respectively. The activity for the three months ended March 31, 2023, included a $1,210 million payment to discharge the $1.9 billion 5.77% senior unsecured term loan facility and a $498 million payment to discharge the $500 million 2.95% notes, due May 2023. Our credit facilities, commercial paper notes and senior unsecured notes outstanding as of March 29, 2024, contain financial covenants and customary restrictive covenants. We were in compliance with all covenants as of March 29, 2024. We paid dividends of $53 million and $50 million during the three months ended March 29, 2024, and March 31, 2023, respectively. 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 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 the three months ended March 29, 2024, and March 31, 2023, we made open market repurchases of our common stock for aggregate purchase price of $150 million and $25 million, respectively. 23 Table of Contents LEIDOS HOLDINGS, INC. 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: Three Months Ended March 29, 2024 March 31, 2023 (in millions) Net cash provided by (used in) operating activities $ 63 $ (98) Net cash used in investing activities (12) (39) Net cash used in financing activities (228) (57) Net cash provided by operating activities increased $161 million during the three months ended March 29, 2024, when compared to the prior year quarter. The increase was primarily due to lower tax payments of $133 million mainly in connection with the Tax Cuts and Jobs Act provision requiring capitalization of research and development costs and a nonrecurring $62 million payment for payroll taxes related to the CARES Act in the prior year quarter, partially offset by a net increase in working capital. Net cash used in investing activities decreased $27 million for the three months ended March 29, 2024, when compared to the prior year quarter, primarily due to lower capital expenditures in the current year quarter. Net cash used in financing activities increased $171 million for the three months ended March 29, 2024, when compared to the prior year quarter, primarily due to a net increase of $140 million in stock repurchases and a decrease of $29 million in net proceeds received from borrowings in connection with the issuance of debt in the prior year quarter. Off-Balance Sheet Arrangements We have outstanding performance guarantees and cross-indemnity agreements in connection with certain aspects of our business. We also 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 11–Commitments and Contingencies" of the notes to the condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q. 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 expenditures or capital resources, operations or financial condition. 24 Table of Contents LEIDOS HOLDINGS, INC. Guarantor and Issuer 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 March 29, 2024 December 29, 2023 (in millions) Total current assets $ 2,451 $ 2,464 Goodwill 5,673 5,517 Other long-term assets 1,289 1,241 Total assets $ 9,413 $ 9,222 Total current liabilities $ 2,125 $ 1,983 Long-term debt, net of current portion 4,636 4,663 Intercompany payables 2,518 2,523 Other long-term liabilities 611 599 Total liabilities $ 9,890 $ 9,768 25 Table of Contents LEIDOS HOLDINGS, INC. Statement of Operations Information for the Guarantor and Issuer of Registered Notes Three Months Ended March 29, 2024 (in millions) Revenues, net $ 2,581 Operating income 202 Net income attributable to Leidos common stockholders 43 Contractual Obligations and Commitments 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 11–Commitments and Contingencies" of the notes to the condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q. Critical Accounting Policies There were no material changes to our critical accounting policies, estimates or judgments during the period covered by this report from those discussed in our Annual Report on Form 10-K for the year ended December 29, 2023. Recently Adopted and Issued Accounting Standards For a discussion of these items, see "Note 1–Basis of Presentation and Summary of Significant Accounting Policies" of the notes to the condensed consolidated financial statements contained within this Quarterly Report on Form 10-Q. 26 Table of Contents LEIDOS HOLDINGS, INC. Item 3. Quantitative and Qualitative Disclosures About Market Risk. There were no material changes in our market risk exposure from those discussed in our Annual Report on Form 10-K for the year ended December 29, 2023.