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 48,000, 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 the three and six months ended June 28, 2024, we generated approximately 86% and 87%, respectively, of total revenues from contracts with the U.S. government, as compared to 85% and 86% for the three and six months ended June 30, 2023, respectively. 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. President Biden released the $7.3 trillion government fiscal year ("GFY") 2025 President’s Budget Request on March 11, 2024, which seeks to increase defense spending by 1% and non-defense discretionary spending by 2.4%. The U.S. Congress is currently working to pass the 12 appropriations bills that will fund the federal government in GFY 2025. Failure to pass the appropriations bills or a continuing resolution by September 30, 2024, will result in a full or partial federal government shutdown. 24 Table of Contents LEIDOS HOLDINGS, INC. International Markets Sales to customers in international markets represented approximately 9% and 8% of total revenues for the three and six months ended June 28, 2024, respectively, as compared to 9% for both the three and six months ended June 30, 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 Six Months Ended June 28, 2024 June 30, 2023 Dollar change Percent change June 28, 2024 June 30, 2023 Dollar change Percent change (dollars in millions) Revenues $ 4,132 $ 3,838 $ 294 7.7 % $ 8,107 $ 7,537 $ 570 7.6 % Operating income 475 331 144 43.5 % 890 596 294 49.3 % Non-operating expense, net (49) (57) 8 (14.0) % (96) (115) 19 (16.5) % Income before income taxes 426 274 152 55.5 % 794 481 313 65.1 % Income tax expense (102) (64) (38) 59.4 % (187) (107) (80) 74.8 % Net income 324 210 $ 114 54.3 % 607 374 233 62.3 % Net income attributable to Leidos common stockholders $ 322 $ 207 $ 115 55.6 % $ 606 $ 369 $ 237 64.2 % Operating margin 11.5 % 8.6 % 11.0 % 7.9 % Segment and Corporate Results Three Months Ended Six Months Ended National Security and Digital June 28, 2024 June 30, 2023 Dollar change Percent change June 28, 2024 June 30, 2023 Dollar change Percent change (dollars in millions) Revenues $ 1,813 $ 1,791 $ 22 1.2 % $ 3,606 $ 3,548 $ 58 1.6 % Operating income 183 172 11 6.4 % 358 317 41 12.9 % Operating margin 10.1 % 9.6 % 9.9 % 8.9 % The increase in revenues for the three and six months ended June 28, 2024, as compared to the three and six months ended June 30, 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 June 28, 2024, as compared to the three months ended June 30, 2023, was primarily attributable to a net increase in volumes and efficiencies on certain programs, partially offset by the completion of certain contracts. The increase in operating income for the six months ended June 28, 2024, as compared to the six months ended June 30, 2023, was primarily attributable to a net increase in volumes and efficiencies on certain programs, and program wins, partially offset by the completion of certain contracts. 25 Table of Contents LEIDOS HOLDINGS, INC. Three Months Ended Six Months Ended Health & Civil June 28, 2024 June 30, 2023 Dollar change Percent change June 28, 2024 June 30, 2023 Dollar change Percent change (dollars in millions) Revenues $ 1,263 $ 1,034 $ 229 22.1 % $ 2,462 $ 2,042 $ 420 20.6 % Operating income 307 134 173 129.1 % 529 247 282 114.2 % Operating margin 24.3 % 13.0 % 21.5 % 12.1 % The increase in revenues for the three and six months ended June 28, 2024, as compared to the three and six months ended June 30, 2023, was primarily attributable to higher volumes in the managed health services business, write-ups on certain programs and program wins. The increase in operating income for the three and six months ended June 28, 2024, as compared to the three and six months ended June 30, 2023, was primarily driven by a net increase in volumes and favorable business mix in the managed health services business and write-ups on certain programs. Three Months Ended Six Months Ended Commercial & International June 28, 2024 June 30, 2023 Dollar change Percent change June 28, 2024 June 30, 2023 Dollar change Percent change (dollars in millions) Revenues $ 561 $ 547 $ 14 2.6 % $ 1,070 $ 1,036 $ 34 3.3 % Operating (loss) income (11) 34 (45) (132.4) % 23 47 (24) (51.1) % Operating margin (2.0) % 6.2 % 2.1 % 4.5 % The increase in revenues for the three and six months ended June 28, 2024, as compared to the three and six months ended June 30, 2023, was primarily attributable to higher material volumes within our Australia business and program wins. The increase was partially offset by the impact of write-downs on certain programs within our UK operations for which cost and schedule were rebaselined. The decrease in operating income for the three and six months ended June 28, 2024, as compared to the three and six months ended June 30, 2023, was primarily driven by the impact of write-downs on certain programs within our UK operations for which cost and schedule were rebaselined, and the completion of certain contracts. The decrease was partially offset by higher material volumes and program wins. Three Months Ended Six Months Ended Defense Systems June 28, 2024 June 30, 2023 Dollar change Percent change June 28, 2024 June 30, 2023 Dollar change Percent change (dollars in millions) Revenues $ 495 $ 466 $ 29 6.2 % $ 969 $ 911 $ 58 6.4 % Operating income 34 21 13 61.9 % 55 44 11 25.0 % Operating margin 6.9 % 4.5 % 5.7 % 4.8 % The increase in revenues for the three and six months ended June 28, 2024, as compared to the three and six months ended June 30, 2023, was primarily attributable to program wins, partially offset by the completion of certain contracts. The increase in operating income for the three months ended June 28, 2024, as compared to the three months ended June 30, 2023, was primarily attributable to program wins and improved program execution on certain programs. The increase in operating income for the six months ended June 28, 2024, as compared to the six months ended June 30, 2023, was primarily attributable to program wins. 26 Table of Contents LEIDOS HOLDINGS, INC. Three Months Ended Six Months Ended Corporate June 28, 2024 June 30, 2023 Dollar change Percent change June 28, 2024 June 30, 2023 Dollar change Percent change (dollars in millions) Operating loss $ (38) $ (30) $ (8) 26.7 % $ (75) $ (59) $ (16) 27.1 % The increase in operating loss for the three months ended June 28, 2024, as compared to the three months ended June 30, 2023, was primarily attributable to increased general and administrative expenses. The increase in operating loss for the six months ended June 28, 2024, as compared to the six months ended June 30, 2023, was primarily attributable to increased general and administrative expenses, partially offset by reduced legal fees. Non-Operating Expense, net Non-operating expense, net for the three months ended June 28, 2024, was $49 million as compared to $57 million for the three months ended June 30, 2023. The decrease was primarily driven by lower interest expense, as there were no commercial paper borrowings in the current year. Non-operating expense, net for the six months ended June 28, 2024, was $96 million as compared to $115 million for the six months ended June 30, 2023. The decrease was primarily driven by lower interest expense, as there were no commercial paper borrowings in the current year, increased interest income on higher cash balances and favorable exchange rate movements. Provision for Income Taxes For the three months ended June 28, 2024, our effective tax rate was 23.9% compared to 23.4% for the three months ended June 30, 2023. The increase to the effective tax rate was primarily due to a reduced benefit in federal research tax credits, partially offset by a reduction of taxes related to foreign operations. In addition, our effective tax rate for the three months ended June 30, 2023, included a benefit from the release of an accrual for penalties. For the six months ended June 28, 2024, our effective tax rate was 23.6% compared to 22.2% for the six months ended June 30, 2023. The increase to the effective tax rate was primarily due to a reduced benefit in federal research tax credits and an increase in unrecognized tax benefits, 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 became effective for certain jurisdictions beginning in fiscal 2024. We will continue to evaluate the impact of the rules as additional legislation gets enacted but currently do not expect them to have a material impact. 27 Table of Contents LEIDOS HOLDINGS, INC. Bookings and Backlog We recorded net bookings worth an estimated $4.0 billion and $7.7 billion during the three and six months ended June 28, 2024, respectively, as compared to $2.9 billion and $5.9 billion for the three and six months ended June 30, 2023, respectively. The estimated value of our total backlog was as follows: June 28, 2024 June 30, 2023 Segment Funded Unfunded Total Funded Unfunded Total (in millions) National Security and Digital $ 2,681 $ 15,268 $ 17,949 $ 2,806 $ 12,549 $ 15,355 Health & Civil 1,607 8,837 10,444 1,635 9,127 10,762 Commercial & International 2,699 1,886 4,585 2,786 972 3,758 Defense Systems 1,036 2,473 3,509 1,045 3,232 4,277 Total $ 8,023 $ 28,464 $ 36,487 $ 8,272 $ 25,880 $ 34,152 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 June 28, 2024, we had $823 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 June 28, 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 June 28, 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 June 28, 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 $5 million and $9 million during the three and six months ended June 28, 2024, respectively, and $325 million and $2,036 million for the three and six months ended June 30, 2023, respectively. The activity for the three months ended June 30, 2023, included a required principal payment of $320 million to discharge the 364-day term loan credit agreement. The activity for the six months ended June 30, 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 June 28, 2024, contain financial covenants and customary restrictive covenants. We were in compliance with all covenants as of June 28, 2024. We paid dividends of $51 million and $104 million during the three and six months ended June 28, 2024, respectively, and $50 million and $100 million during the three and six months ended June 30, 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. 28 Table of Contents LEIDOS HOLDINGS, INC. During the three and six months ended June 28, 2024, we made open market repurchases of our common stock for an aggregate purchase price of $100 million and $250 million, respectively, and $25 million during the six months ended June 30, 2023.There were no share repurchases for the three months ended June 30, 2023. 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 Six Months Ended June 28, 2024 June 30, 2023 June 28, 2024 June 30, 2023 (in millions) Net cash provided by operating activities $ 374 $ 164 $ 437 $ 66 Net cash used in investing activities (21) (44) (33) (83) Net cash used in financing activities (159) (164) (387) (221) Net cash provided by operating activities increased $210 million during the three months ended June 28, 2024, when compared to the prior year quarter. The increase was primarily due to higher earnings and a favorable change in working capital. Net cash provided by operating activities increased $371 million during the six months ended June 28, 2024, when compared to the prior year. The increase was primarily due to higher earnings and lower tax payments of $116 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, partially offset by an unfavorable change in other working capital. Net cash used in investing activities decreased $23 million and $50 million, respectively, for the three and six months ended June 28, 2024, when compared to the prior year quarter, primarily due to lower capital expenditures. Net cash used in financing activities decreased $5 million for the three months ended June 28, 2024, when compared to the prior year quarter, primarily due to a decrease of $120 million in net payments made from debt activities, partially offset by a net increase of $114 million in stock repurchases. Net cash used in financing activities increased $166 million for the six months ended June 28, 2024, when compared to the prior year. The increase was primarily due to a net increase of $225 million in open market share repurchases and $29 million increase in shares withheld for tax obligations, partially offset by a decrease of $91 million in net payments made from debt activities. 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. 29 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 June 28, 2024 December 29, 2023 (in millions) Total current assets $ 2,520 $ 2,464 Goodwill 5,673 5,517 Other long-term assets 1,323 1,241 Total assets $ 9,516 $ 9,222 Total current liabilities $ 2,531 $ 1,983 Long-term debt, net of current portion 4,108 4,663 Intercompany payables 2,817 2,523 Other long-term liabilities 618 599 Total liabilities $ 10,074 $ 9,768 30 Table of Contents LEIDOS HOLDINGS, INC. Statement of Operations Information for the Guarantor and Issuer of Registered Notes Six Months Ended June 28, 2024 (in millions) Revenues, net $ 5,189 Operating income 434 Net income attributable to Leidos common stockholders 89 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. 31 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.